Download EN EN Results of in-depth reviews under Regulation (EU) No 1176

EUROPEAN
COMMISSION
Brussels, 5.3.2014
SWD(2014) 91 final
COMMISSION STAFF WORKING DOCUMENT
Macroeconomic Imbalances - United Kingdom 2014
EN
EN
Results of in-depth reviews under Regulation (EU) No 1176/2011 on the prevention and correction of
macroeconomic imbalances
The United Kingdom continues to experience macroeconomic imbalances, which require monitoring and policy
action. In particular, developments in the areas of household debt, linked to the high levels of mortgage debt and
structural characteristics of the housing market, as well as unfavourable developments in export market shares,
continue to warrant attention.
More specifically, while recent growth in economic activity is welcome, it is driven mostly by household
consumption and is accompanied by a rising current account deficit. Business investment and net exports are yet
to pick up from their current low levels. Containing high indebtedness, in particular of the household sector,
while minimising the impact on investment and growth, would help limit medium-term risks and vulnerability to
rises in the cost of borrowing. Credit growth for mortgage loans has been modest but rising from high preexisting levels of household indebtedness. The risks in the housing sector relate to a continuing structural undersupply of housing; the relatively slow response of supply to increases in demand results in high house prices,
particularly in London and the Southeast, and in household mortgage indebtedness. While the declining export
market share is unlikely to pose short-term risks, together with the current account deficit, it still points to
structural challenges. These are related to skills gaps and a low level of infrastructure endowment. As regards
public finances, the UK seems to continue missing its headline deficit targets and its structural adjustment targets
by wide margins.
Excerpt of country-specific findings on The United Kingdom, COM(2014) 150 final, 5.3.2014
2
Executive Summary and Conclusions
7
1.
Introduction
9
2.
Macroeconomic Developments
11
3.
Imbalances and Risks
15
3.1.
Export Share and Competitiveness
15
3.1.1. The current account deficit
15
3.1.2. Export shares challenge
16
3.1.3. The impact of the depreciation
19
3.1.4. Policy responses: Infrastructure, skills and SME finance
21
3.1.5. Conclusions
27
Private Sector Indebtedness
28
3.2.1. Introduction
28
3.2.2. Trends and developments
28
3.2.3. Credit supply
30
3.2.4. Cost of credit
32
3.2.5. Near-term outlook for credit supply and demand
33
3.2.6. Risks
33
3.2.7. Government policy – developments and impact
36
3.2.8. Conclusion
38
The Housing Sector and Household Mortgage Indebtedness
38
3.3.1. Introduction
38
3.3.2. Trends and Developments
39
3.3.3. Risks
44
3.3.4. Government policy - responses and challenges
49
3.3.5. Conclusion
52
3.2.
3.3.
4.
Policy Challenges
References
55
58
LIST OF TABLES
2.1.
Key economic, financial and social indicators - United Kingdom
14
3.1.
Elasticity of supply
48
3
LIST OF GRAPHS
4
2.1.
External and domestic demand - growth contribution
11
2.2.
Youth unemployment rate (% of youth labour force aged 15-24)
11
2.3.
Debt Decomposition, all sectors, consolidated
12
2.4.
Decomposition of credit flows, consolidated
13
3.1.
Decomposition of external position (current and capital accounts)
15
3.2.
Export shares
16
3.3.
Investment and gross savings
16
3.4.
UK's world market share for services
17
3.5.
Goods export: geographical and sectoral composition
17
3.6.
Dynamism and competitiveness of goods export
19
3.7.
Export destinations, goods
19
3.8.
Exchange rate developments
19
3.9.
Deflator of exports
19
3.10. Decomposition of REER
20
3.11. Nominal effective exchange rate (NEER)
20
3.12. Unit labour costs and its components
20
3.13a. UK firm-level Return on Assets, industry medians
21
3.13b. France, Italy and Spain firm-level Return on Assets, industry medians
21
3.14. Transport gross investment spending (exluding maintenance)
22
3.15a. Beveridge curve - pre- and post-crisis
24
3.15b. Beveridge curve - by duration of unemployment, after 2008
24
3.16. Lending to UK private non-financial corporations
26
3.17. Corporate credit costs by firm size
26
3.18. Lending to UK private non-financial corporations
26
3.19. Households' and PNFCs' indebtedness
28
3.20. PNFCs' debt as percentage of gross operating surplus
29
3.21. Measures of PNFCs' leverage
29
3.22. Household debt as a percentage of gross disposable income
29
3.23. Composition of household deleveraging
29
3.24. Gross operating surplus and household gross disposable income
30
3.25. Household saving ratio
30
3.26. Credit growth by sector
30
3.27. Economic sentiment and consumer confidence
32
3.28. PNFCs' cost of borrowing
33
3.29. Stock of UK loans by sector a)
35
3.30. PNFCs' profitability ratios
35
3.31. PNFCs' financial assets
35
3.32. Liabilities and Loans/Deposits Ratio, Financial Corporations
36
3.33. Homeownership rate
39
3.34. Property transactions
39
3.35. Number of loans approval for house purchase and for remortgaging, seasonally adjusted
39
3.36. Measures of near-term demand
39
3.37. Quoted mortgage rates
40
3.38. 2-Year fixed mortgage Rate and 2-Year Swap Rates
40
3.39. Net balance of consumers that believe that now is a good time in which to make a major
purchase
40
3.40. Private sector housing starts and completions
41
3.41. House Price Index
42
3.42a. Selling price achieved as a share of the asking price
42
3.42b. House price expectations 12-months ahead
42
3.43. House prices to disposable income
42
3.44. Price to rent
42
3.45. Mortgage interest payments as a percentage of household disposable income
43
3.46. Regional house price developments
43
3.47. Regional house prices (change in levels)
43
3.48. Housing affordability by region
43
3.49. Mortgage approvals and house price growth
44
3.50. House prices and mortgage debt
44
3.51. Market expectations of future yields
45
3.52. Mortgage arrears and repossession rates
46
3.53. Proportion of mortgage applications approved (% balance)
46
3.54. Housing tenure and housing cost overburden rates
52
LIST OF BOXES
3.1.
The Financial and Insurance services sector
18
3.2.
PNFCs - supply and demand for credit.
31
3.3.
Sources of funds for PNFCs
34
5
EXECUTIVE SUMMARY AND CONCLUSIONS
In April 2013, the Commission concluded that the United Kingdom was experiencing macroeconomic
imbalances, relating to household debt, the housing market and, to a lesser extent, external
competitiveness. In the Alert Mechanism Report (AMR), published on 13 November 2013, the
Commission found it useful, also taking into account the identification of an imbalance in April, to
examine further the persistence of imbalances or their unwinding. To this end, this In-Depth Review
(IDR) provides an economic analysis of the UK economy in line with the scope of the surveillance under
the Macroeconomic Imbalance Procedure (MIP). The main observations and findings from this analysis
are:
 Growth picked up markedly in 2013 at 1.8% compared with 0.3% in 2012 and is projected to
increase further to 2.5% in 2014. Growth in the UK outstripped that in the euro area (-0.4% in
2013), the largest export market for the UK. However, growth has been driven predominantly by
household demand and has been accompanied by a rise in the current account deficit. In 2013,
domestic demand contributed 1.6 pps. to growth, driven mainly by an upswing in private consumption
while net exports contributed slightly to growth by 0.1 pp. A more broadly based recovery is desirable
in which both business investment and net exports contribute positively to growth.
 The export market share continues to decline although it has stabilised recently and the pace of
decline has fallen. Reflecting the impact of the international economic crisis, financial services
exports have fallen. Following the strong depreciation of sterling in 2008-2009, exporters responded
by raising margins instead of increasing market share so the impact of the depreciation on export
growth has been relatively subdued. The risks associated with the declining export share are less
marked in the short term but are higher in the medium term - the current account deficit may gradually
increase over the medium term should the export market share continue to deteriorate. Structural
challenges to raising exports include a low level of infrastructure endowment, skills gaps, in
particular, in technical areas and constrained access to finance for Small and Medium-sized
Enterprises (SMEs). Policy initiatives are being developed to address these issues.
 Fiscal consolidation is underway which aims to stabilise and reverse the high general
government debt ratio which averaged around 40% of GDP in the decade before the international
economic crisis but rose swiftly to reach almost 90% of GDP in 2012-13. The budget deficit was
below 3% of GDP in 2007-08 but increased rapidly to peak at 11.4% in 2009-10. Reflecting the
impact of a substantial and necessary fiscal consolidation, the budget deficit fell to 5.2% in 2012-13.
The fiscal consolidation is expected to continue and, as a result, the deficit is projected to decrease
further with the pace of increase in general government indebtedness falling. The UK is currently
subject to an Excessive Deficit Procedure.
 Although the pace of private sector deleveraging has slowed recently, private sector
indebtedness has fallen significantly from its peak, in particular, for private non-financial
corporations (PNFCs). PNFCs' balance sheets are strong and the PNFC sector is a net lender to the
rest of the economy suggesting that the sector is resilient despite the slowing in deleveraging; the risks
posed by high PNFCs' debt are less marked than at the time of the 2013 IDR.
 Household sector indebtedness, despite having declined from its peak, remains high and
continues to pose risks. Households' debt predominantly comprises mortgages secured against
houses. Demand for houses is increasing, reflecting increased confidence, the low cost of borrowing
and easing credit constraints. The increase in supply of new properties has, however, been muted. As a
result, house prices are rising and household mortgage indebtedness is expected to increase. In the
short term, the increase in housing supply is likely to remain below that of household formation
although the government is implementing reforms to boost the supply of land and the stock of housing
in the short and medium terms. The housing market is marked by divergent developments in London
and the rest of the UK. In the year to November 2013, house prices increased by 5.4% largely driven
7
by rises in London where prices increased by 11.6% whereas, excluding London and the south east,
house prices increased modestly by 3.1%.
 Credit constraints are easing for households and credit supply is rising. However, credit supply
continues to fall for PNFCs – it fell by 3.4% in the year to December 2013 – while, for households,
secured lending increased in the same period by 0.9%. There is a need to ensure adequate access to
finance for PNFCs, particularly SMEs, that need it to invest and expand. Policies are in place to help
address the issue.
This IDR analyses these imbalances and associated risks and challenges. It considers a number of ways in
which government policy can address the challenges, minimise the risks associated with any imbalance
and prevent it from worsening.
 To improve external competitiveness, improvements in infrastructure, skills, credit access for
SMEs and export promotion could be considered. Firstly, transport bottlenecks and capacity
shortages could be addressed by investing in infrastructure. The UK government's National
Infrastructure Plan 2013 sets out ambitious plans to boost the quality and quantity of national
infrastructure and envisages investment of GBP 375 billion, a significant portion (around threequarters) of which is private sector funding; effective implementation and harnessing private sector
funding is key. Secondly, businesses require a labour force with specific intermediate and advanced
technical skills in order to expand. Gaps in this area could be reduced by focussing on STEM (science,
technology, engineering and mathematics) skills and apprenticeships and cooperating with businesses
in order to identify the professional and technical skills required by the tradable sector. The
government published an implementation plan on apprenticeships and has initiatives in place to raise
vocational skills. Thirdly, whilst credit constraints have diminished, particular challenges surrounding
access to credit remain for SMEs. The establishment of the Business Bank is a positive step and
should help SMEs obtain alternative sources of finance while the refocussing of the Funding for
Lending Scheme to PNFCs only should help all PNFCs including SMEs. Fourthly, exports could be
stimulated by providing export credit where constraints exist. Finally, facilitating the recruitment of
foreign experts could improve external mobility and ability to engage in international trade.
 To minimise the risks associated with rising house prices and high household indebtedness,
there is a need to address the short and medium term imbalance between supply and demand
for property. A number of useful policy initiatives are being implemented but there is scope for
further action. In relation to demand, at a time in which credit constraints are easing in the mortgage
market, the need for the Help to Buy 2 policy may diminish. Close monitoring of credit availability
and associated macroeconomic developments is required given the risks associated with Help to Buy 2
and the policy could be scaled back – and/or more closely targeted – should credit supply growth rise
further and credit constraints continue to ease. In relation to macro-prudential regulation of credit
conditions in the housing sector, there is a case for a more detailed public assessment by the Financial
Policy Committee of the Bank of England of the merits of the various instruments available to it and
the situations in which they would be deployed to increase markets' knowledge of its approach to
regulation. In relation to supply, there is scope to consider the development of appropriate and
targeted incentives for local authorities to release land with planning permission attached for
development in the context of local solutions to inadequate supply. Local solutions may also include
the taxation of vacant property. In relation to taxation, revaluation of the property roll would reduce
distortions in the taxation system in favour of owner-occupied housing.
8
1.
INTRODUCTION
On 13 November 2013, the European Commission presented its third Alert Mechanism Report (AMR),
prepared in accordance with Article 3 of Regulation (EU) No. 1176/2011 on the prevention and
correction of macroeconomic imbalances. The AMR serves as an initial screening device helping to
identify Member States that warrant further in depth analysis to determine whether imbalances exist or
risk emerging. According to Article 5 of Regulation No. 1176/2011, these country-specific “in-depth
reviews” (IDR) should examine the nature, origin and severity of macroeconomic developments in the
Member State concerned, which constitute, or could lead to, imbalances. On the basis of this analysis, the
Commission will establish whether it considers that an imbalance exists in the sense of the legislation and
what type of follow-up in terms it will recommend to the Council.
This is the third IDR for the United Kingdom. The previous IDR was published on 10 April 2013 on the
basis of which the Commission concluded that the UK was experiencing macroeconomic imbalances, in
particular as regards developments related to household debt, the housing market and, to some extent,
external competitiveness. Overall, in the AMR, the Commission found it useful, also taking into account
the identification of an imbalance in May, to examine further the persistence of imbalances or their
unwinding. To this end, this IDR provides an economic analysis of the UK economy in line with the
scope of the surveillance under the Macroeconomic Imbalance Procedure (MIP).
Section 2 provides an overview of general macroeconomic developments, section 3 considers the main
imbalances and risks, including on export share, private indebtedness and the housing sector and section 4
discusses policy considerations.
9
2.
MACROECONOMIC DEVELOPMENTS
Growth and inflation
Unemployment and poverty
The recovery since the international economic
crisis had been slow and protracted until 2013.
However, 2013 finally saw a decisive shift towards
a more sustained recovery in which growth
reached 1.8%. The main source of growth was
domestic
demand,
particularly
private
consumption. Net exports detracted from growth in
2012 but made a small positive contribution in
2013. Despite the pick up in growth in 2013, the
economy remains 1.4% below the pre-crisis peak.
Growth is projected to rise further in 2014 to 2.5%,
stabilise somewhat thereafter and broaden as
growth gross fixed capital formation increases and
the contribution to growth from net exports
becomes positive but remains small (Graph 2.1).
The unemployment rate peaked at 8.4% in the
final quarter of 2011 and has fallen consistently
since then. In the final quarter of 2013, the
unemployment rate was 7.2%. The fall in the
unemployment rate has occurred as strong rises in
private sector employment have outweighed
reductions in public sector employment. Between
the third quarter of 2009 and the same quarter in
2013, public sector employment has fallen by
some 10.6% (1). However, the improvements in
employment have been accompanied by stagnant/
declining levels of productivity.
6
Graph 2.1: External and domestic demand growth contribution
4
The regions with the highest unemployment
rates in England are the North East and West
Midlands and the rate increased in those regions
in 2013. The lowest rates are in the East of
England, and are falling, thereby contributing to an
inter-regional division (2).
2
%, pps
25
Graph 2.2: Youth unemployment rate (% of
youth labour force aged 15-24)
0
20
-2
15
%
-4
-6
10
-8
99 00 01 02 03 04 05 06 07 08 09 10 11 12 13*14*15*
Inventories investment
Consumption
Real GDP growth
Investment (GFCF)
Net exports
* estimated
Source: Commission Services
5
0
01
03
05
07
09
11
13
Youth unemployment rate (% of youth labour force aged 15-24)
Unemployment rate (% of labour force, age group 15-74)
Inflation has been on a downward trajectory
since September 2011 when it peaked at a 5.2%.
Following some stickiness in the twelve months
from October 2012 in which inflation averaged
2.7%, the rate has fallen more quickly in recent
months to 1.9% in January 2014. The recent
decline can be attributed to a fall in oil prices,
delayed rises in utility charge increases and lowerthan-expected increases in education costs.
Inflation is expected to remain around the Bank of
England’s 2% target.
Source: Commission Services
Youth unemployment has increased over the
past ten years and reached 21% in 2012 (Graph
2.2) (3). Furthermore, almost one-third of youth
have been unemployed for more than one year.
Long-term unemployment has increased over the
past decade and reached 2.7% in 2012 (4). Poverty
indicators provide a mixed picture as the severe
(1) However, it should be noted that part of the decline is due
to the reclassification of further education and sixth form
colleges in England from the public to the private sector in
2012; this accounts for 3.2 pp. of the decline.
2
( ) ONS Labour market statistics, December 2013.
(3) Eurostat data.
(4) Idem.
11
2. Macroeconomic Developments
material deprivation rate rose from 2008 to 2012
(the date of the last available data) (5); however,
the at-risk of poverty or social exclusion rate has
declined since 2005 and is now below the precrisis level.
Potential growth
In 2014, potential growth is projected at 1%(6),
around one-half of the level just prior to the
crisis. Low potential growth reflects low
productivity growth and the combination of a
resilient labour market and growth in employment
that outstripped that in GDP. Low productivity is
likely to reflect a combination of factors such as
the lower price of labour relative to capital leading
to a rise in demand for labour, albeit possibly less
productive labour, a rise in employment in less
productive sectors of the economy and forbearance
and cheap credit allowing some firms to remain in
the market from which they would otherwise have
exited.
In 2012, the Greater South East (London, the
South East and East of England regions)
contributed 45.4% of total Gross Value Added
(GVA). This was an increase from 44.3% in 2007
and 43.1% in 2001. London alone accounted for
22.4% of GVA in 2012 and grew by 2.0% over the
year; higher than the UK average of 1.6%.
investments. In 2013, the current account balance
reached a deficit of 3.8% of GDP.
The fiscal position
Fiscal consolidation has been underway since
the June 2010 Budget. This has resulted in a
6.2 pp. fall in the budget deficit to 5.2% of GDP in
2012-13. The consolidation has been assisted by
certain one-off items which account for
approximately one-third of the decline.
Furthermore, the ongoing transfers from the Bank
of England’s Asset Purchase Facility also
contributed to the decline ( 7). Gross government
debt continues to increase and reached 88.1% of
GDP in 2012-13.
Private sector debt
Private sector debt peaked at 195% of GDP in
2009 and has been declining since then although
it remains high (Graph 2.3). Household debt and
corporate debt both remain high despite having
declined since 2009 and the pace of decline has
fallen. The household savings ratio was high in
2012 but fell somewhat in 2013.
400
Graph 2.3: Debt Decomposition, all sectors,
consolidated
The external side
Although the deterioration in export market
share reversed in 2013, net exports only
contributed 0.1pp to growth. The trade balance
for services has been improving recently although
the goods balance has been deteriorating. Exports
are reorienting towards non EU markets but the
EU still accounts for the largest export share by
destination. In 2012, the single largest destination
for exports was the US (13.7% of total exports),
followed by Germany (10.6%) whereas China
accounted for 3.5% of total exports. Growth in net
exports is projected to remain subdued in 2014 in
part reflecting relatively subdued growth in the
euro area.
Along with weak export growth, there has been
a sharp deterioration in earnings on overseas
(5) Macroeconomic Imbalance Procedure Scoreboard
(6) Commission services Winter 2014 Forecast.
12
% of GDP
300
200
100
0
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12
Non financial corporations
Household
Financial corporations
Government
MIP Threshold
Source: Commission Services
During 2013, activity in the housing market
increased with prices rising from an already
elevated level. The strongest rises were in London
and the South East.
(7) As a result of quantitative easing, the coupon payments
linked to assets held by the Bank of England Asset
Purchase Facility Fund Limited (BEAPFF), a subsidiary of
the Bank of England, are being transferred to the general
government accounts.
2. Macroeconomic Developments
The financial sector and credit
Credit conditions have been improving for
households although the supply of credit
remains muted for corporates (Graph 2.4).
According to the Bank of England’s Credit
Conditions Survey(8), the overall availability of
credit for both small and large corporates increased
significantly in the final quarter of 2013. This was
the fifth consecutive quarter of increases. Secured
credit to households also rose including for
borrowers with high loan-to-value ratios. This
trend may have been affected by the Help to Buy
scheme. However, despite positive signs from
surveys, overall credit growth remains low and
continues to decline for corporates.
A number of government policies have been
designed to improve the flow of credit in the
economy, in particular, the Funding for Lending
scheme (FLS) and quantitative easing (QE). The
FLS was introduced in July 2012 and was
extended by one year in April 2013; however, in
November 2013, the terms of the lending were
changed, effective from 1 January 2014, by
excluding lending to households and focussing
solely on corporate lending. As part of QE,
between March 2009 and July 2012, the Bank of
England purchased GBP 375 billion worth of
government bonds but has not returned to the
market since then.
35
2014. The Bank aims to assist SMEs to obtain
alternative sources of funds.
Throughout 2013, the eight major banks and
building societies continued to eradicate capital
shortfalls based on the Prudential Regulation
Authority's (PRA) recommendations of March
2013. By September, three-quarters of the
shortfalls had been addressed in the banks in which
issues had been identified. This represented a
1.5 pp. improvement in their capital ratios. Banks
that were not identified as having a shortfall also
took actions which raised their capital ratios by
0.5 pp. in aggregate. The Bank of England and the
PRA are also developing a regular stress-testing
framework to assess the resilience of the banking
system to housing-related portfolios, among
others, with the first tests to be carried out in 2014.
Furthermore, stronger mortgage underwriting
standards will be implemented in the context of the
Mortgage Market Review from April 2014.
Graph 2.4: Decomposition of credit flows,
consolidated
30
25
% of GDP
20
15
10
5
0
-5
-10
96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12
Financial corporations
Non financial corporations
Government
Household
MIP Threshold
Source: Commission Services
The government is establishing a Business Bank
which should be operational by the second half of
(8) Bank of England (2014).
13
2. Macroeconomic Developments
Table 2.1:
Key economic, financial and social indicators - United Kingdom
14
Real GDP (yoy)
Private consumption (yoy)
Public consumption (yoy)
Gross fixed capital formation (yoy)
Exports of goods and services (yoy)
Imports of goods and services (yoy)
Output gap
2007
3.4
2.7
0.7
7.5
-2.0
-1.5
2.6
2008
-0.8
-1.0
2.1
-6.9
1.1
-1.7
0.5
2009
-5.2
-3.6
0.7
-16.7
-8.7
-10.7
-5.1
2010
1.7
1.0
0.5
2.8
6.7
7.9
-4.0
2011
1.1
-0.4
0.0
-2.4
4.5
0.3
-3.3
2012
0.3
1.5
1.6
0.7
1.1
3.1
-3.4
2013
1.8
2.3
0.9
-1.5
0.8
0.4
-2.4
Forecast
2014
2.5
2.4
0.5
6.5
2.9
2.6
-0.9
2015
2.4
2.2
0.4
7.1
3.7
3.3
0.2
Contribution to GDP growth:
Domestic demand (yoy)
Inventories (yoy)
Net exports (yoy)
3.2
0.3
-0.1
-1.3
-0.2
0.8
-4.5
-1.5
0.8
0.8
1.3
-0.5
-0.6
0.5
1.2
1.4
-0.2
-0.7
1.6
0.3
0.1
2.6
-0.1
0.0
2.5
-0.1
0.1
Current account balance BoP (% of GDP)
Trade balance (% of GDP), BoP
Terms of trade of goods and services (yoy)
Net international investment position (% of GDP)
Net external debt (% of GDP)
Gross external debt (% of GDP)
Export performance vs. advanced countries (5 years % change)
Export market share, goods and services (%)
-2.4
-3.2
0.0
-22.6
43.3
392.1
-10.0
4.2
-1.3
-3.3
-0.9
-6.9
37.3
436.4
-14.9
3.8
-1.4
-2.2
-0.6
-20.8
45.7
410.0
-14.2
3.8
-3.3
-2.8
-0.3
-23.5
45.6
407.8
-16.4
3.5
-1.3
-1.9
-1.6
-16.8
44.1
419.6
-18.6
3.5
-3.7
-2.4
0.0
-9.8
31.5
385.3
-10.4
3.4
.
.
1.1
.
.
.
.
.
.
.
0.8
.
.
.
.
.
.
.
1.0
.
.
.
.
.
Savings rate of households (Net saving as percentage of net disposable income)
Private credit flow (consolidated, % of GDP)
Private sector debt, consolidated (% of GDP)
-3.7
15.3
180.8
-2.7
9.5
189.8
2.3
-7.3
195.6
2.9
-0.6
183.3
2.2
-1.3
179.8
2.8
2.6
178.6
.
.
.
.
.
.
.
.
.
Deflated house price index (yoy)
8.0
-4.1
-9.6
3.2
-4.7
-0.9
.
.
.
Residential investment (% of GDP)
4.4
3.8
3.0
3.4
3.4
3.3
.
.
.
Total Financial Sector Liabilities, non-consolidated (yoy)
Tier 1 ratio (1)
Overall solvency ratio (2)
Gross total doubtful and non-performing loans (% of total debt instruments and total
loans and advances) (2)
16.7
.
.
48.0
.
.
-17.6
.
.
8.2
.
.
8.9
.
.
-4.3
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
Employment, persons (yoy)
Unemployment rate
Long-term unemployment rate (% of active population)
Youth unemployment rate (% of active population in the same age group)
Activity rate (15-64 years)
Young people not in employment, education or training (% of total population)
People at-risk poverty or social exclusion (% total population)
At-risk poverty rate (% of total population)
Severe material deprivation rate (% of total population)
Persons living in households with very low work intensity (% of total population)
0.7
5.3
1.3
14.3
75.5
11.9
22.6
18.6
4.2
10.3
0.7
5.6
1.4
15.0
75.8
12.1
23.2
18.7
4.5
10.4
-1.6
7.6
1.9
19.1
75.7
13.3
22.0
17.3
3.3
12.6
0.2
7.8
2.5
19.6
75.5
13.7
23.2
17.1
4.8
13.1
0.5
8.0
2.7
21.1
75.7
14.3
22.7
16.2
5.1
11.5
1.2
7.9
2.7
21.0
76.3
14.0
24.1
16.2
7.8
13.0
1.3
7.5
.
.
.
.
.
.
.
.
1.3
6.8
.
.
.
.
.
.
.
.
1.0
6.5
.
.
.
.
.
.
.
.
GDP deflator (yoy)
Harmonised index of consumer prices (yoy)
Nominal compensation per employee (yoy)
Labour Productivity (real, person employed, yoy)
Unit labour costs (whole economy, yoy)
Real unit labour costs (yoy)
REER (ULC, yoy)
REER (HICP, yoy)
2.3
2.3
4.8
2.7
2.0
-0.3
1.6
1.5
3.2
3.6
1.7
-1.5
3.2
0.0
-13.2
-12.8
2.2
2.2
2.4
-3.6
6.2
3.9
-8.6
-9.5
3.1
3.3
3.1
1.5
1.7
-1.4
2.7
0.9
2.3
4.5
2.0
0.6
1.4
-0.9
-0.6
0.5
1.7
2.8
1.9
-0.9
2.9
1.2
5.5
4.3
1.9
2.6
1.9
.
1.0
-0.6
.
.
1.9
2.0
2.1
.
0.9
-1.0
.
.
2.1
2.0
2.8
.
1.4
-0.7
.
.
-2.8
-5.0
-11.4
-10.1
-7.7
-6.1
General government balance (% of GDP)
-4.4
-5.1
-9.0
-8.4
-6.4
-6.5
Structural budget balance (% of GDP)
43.7
51.9
67.1
78.4
84.3
88.6
General government gross debt (% of GDP)
(1) domestic banking groups and stand-alone banks.
(2) domestic banking groups and stand alone banks, foreign (EU and non-EU) controlled subsidiaries and foreign (EU and non-EU) controlled branches.
Source: Eurostat, ECB, AMECO
-6.3
-5.3
91.4
-5.2
-4.8
93.4
-4.2
-4.3
94.5
3.1.
IMBALANCES AND RISKS
EXPORT SHARE AND COMPETITIVENESS
The 2013 IDR described the external dimension
of the UK economy as "less as a source of
macroeconomic instability, and more a field of
often underexploited growth possibilities". The
reasons for the deterioration in the export share
were analysed in the 2012 and 2013 IDRs. This
IDR sets out an update of developments in the
current account balance and export share and
examines the role of government policy in
addressing potential bottlenecks to export growth
including in relation to infrastructure, access to
finance and skills.
3.1.1. The current account deficit
The UK has registered persistent current
account deficits since the late 1990s and stood at
3.8% of GDP in 2013. For more than 15 years, the
current account balance showed a consistent trend
- a negative and increasing goods balance goods
and, while slightly smaller, a positive and
increasing services balance (Graph 3.1). However,
both have flattened recently. The trade deficit
increased steadily over most of the past 15 years
although it too has stabilised in the last few years.
In 2013, the trade deficit in goods is projected to
have reached almost 7% of GDP while the surplus
in services stood at almost 5% of GDP.
The deterioration in the current account
balance following the international economic
crisis was dominated by movements in the
income balance. Historically, the income balance
has been in surplus but has recently moved into
deficit and contributed to the rise in the current
account deficit. The deterioration appears to be
mostly driven by differential returns between
inward and outward investment of the UK.
Notably, the UK has been growing at a faster pace
than the EU - its most important trading partner
and investment destination (the EU absorbs about
half of the UK's exports and accounts for
approximately 40% of its inward investment). As a
consequence, profits earned by UK companies on
investments abroad may have developed less
favourably than those of inward investment. A
recovery in net investment income in 2014 is
projected, which should – if sustained over the
medium term - contribute to a narrowing of the
deficit (9).
10
Graph 3.1: Decomposition of external position (current
and capital accounts)
5
% of GDP
3.
0
-5
-10
96
98
00
02
04
Capital account (KA)
Income balance
Trade balance - goods
Current account balance (CA)
06
08
10
12
Current transfers
Trade balance - services
Trade balance
Net lending/borrowing (CA+KA)
Source: Commission Services
The pattern of recent economic growth in the
UK compared with its major trading partners
might explain part of the deterioration in the
trade balance. Since the end of 2009, growth has
been driven by growth in domestic demand rather
than net exports (as discussed in Chapter 2).
Recently, growth in the UK has outstripped that in
the euro area – for example, the UK grew by 1.8%
in 2013 compared with -0.4% for the euro area –
which may have affected relative import and
export growth to the detriment of the trade
balance. As domestic demand picks up further,
imports are likely to increase further which is
likely to result in a further deterioration in the
trade balance should growth in imports continue to
outstrip growth in exports. Nevertheless, relative
losses in export market share stabilised in 2012
and 2013 (Graph 3.2).
(9) European Commission (2013d).
15
3. Imbalances and Risks
30
Graph 3.2: Export shares
consistent with an increase in savings and
investment.
10
Graph 3.3: Investment and gross savings
0
20
-10
18
-20
16
% of GDP
Rate of change y-o-y (%)
20
-30
-40
97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13
Denominator: World Export growth (neg. sign)
Numerator: Export growth
EMS growth rate
Source: Commission Services
14
12
10
8
00 01 02 03 04 05 06 07 08 09 10 11 12 13
Gross fixed capital formation
The deterioration in the current account deficit
may be associated with movements in gross
savings and investment (Graph 3.3). Since the
international economic crisis, domestic demand
has been sustained by a substantial decline in the
national savings rate. Gross national savings have
fallen sharply from 16% of GDP in 2008 to 10% of
GDP in 2013 and have been accompanied by a fall
in investment from over 17% of GDP before the
crisis to below 14% of GDP. Neither the fall in
investment nor the deterioration in the current
account is consistent with balanced medium-term
growth.
The prospect of a more balanced pattern of
growth depends on a shift in the composition of
growth towards exports and investment. Despite
rising recently, the current account deficit is
associated with a modestly negative net investment
position of -9% of GDP in 2012 and zero in 2013.
Furthermore, these developments need to be seen
in the context of a floating exchange rate, which
facilitates external adjustment.
However, if the current pattern of growth is to
become more balanced, growth in investment
and net exports need to rise to complement
growth in household consumption so that
balanced growth is accompanied by a fall in the
current account deficit and an increase in the
net savings rate in the order of a significant 7%
of GDP. To achieve this feat in a growing
economy, improved external performance plays a
crucial a role. Rebalancing away from domestic
demand towards net exports would be also
16
Gross saving
Source: Commission Services
The medium-term prospects for net exports
need to be analysed in the context of several
potential adverse developments which include:
the loss in export market share, especially for
services exports, the long-term decline in goods
exports, the muted response of exports in the wake
of the substantial depreciation of sterling and the
fall in financial services exports since the start of
the international economic crisis.
3.1.2. Export shares challenge
In the five years to 2012, the UK lost
approximately 20% of its export market share
in goods and services although the pace of
decline slackened in 2012. There is not a single
obvious driver of the decline in export shares.
Rather, it is determined by a number of factors
including weakness in exports of financial
services, itself reflecting broader weakness in the
financial sector, and the mix of destinations and
product markets for export. Other factors may
include impaired access to finance for exporters
and long-standing issues relating to the quality and
quantity of infrastructure and skills.
Despite the relative strength in exports of services
(contributing 4.5pp of GDP to the current account
balance in 2012), the UK's world market share for
services decreased from 7.9% in 2000-2001 to
6.6% in 2010-2011. A breakdown by industry
shows an across-the-board decline in most sectors
over the past ten years (Graph 3.4), including, in
particular, a decrease in the world market share of
3. Imbalances and Risks
the financial and insurance services industries (see
Box 3.1).
Graph 3.4: UK's world market share for
services
Financial
services
Insurance
services
graph, which means that - except for Switzerland
and China – they are either losing dynamism or the
UK is losing share in those countries compared to
other export competitors.
Other Services
Transportation
Travel
Total Services
0
10
2000-2001
20
30
Annual arithmetic average mean (%)
2
Graph 3.5: Goods export: geographical and
sectoral composition
0
-2
-4
-6
Initial geographical specialisation
-8
Initial product specialisation
-10
Market share gains in
geographical destinations
-12
-14
Market share gains in product
markets
-16
2006-2008
2008-2010
2010-2012
2011-2012
Source: Commission Services
Source: COMTRADE data (HS 1992 Commodity Classification),
Commission Services
The persistence of a deficit in the goods trade
balance reflects deep-rooted characteristics of
the economy. The trade balance is marked by a
structural shift toward services and increased
competition from emerging markets for goods
exports. The weakness in certain goods exports is
also linked to intense competition in export
destinations. A decomposition of the nominal
growth of goods exports by geographical
specialisation and product specialisation (Graph
3.5) shows that, between 2006 and 2008, the
decline of market share was driven mainly by the
loss of market share within existing destinations
and product markets rather than the 'dynamism' (10)
of such destinations and markets (11).
More recently – between 2010 and 2012 - the UK
gained market share in its export destinations,
which, however, are losing 'dynamism'. Graph 3.6
shows the relationship, in the top-10 destinations
for UK goods exports, between the growth in
imports of these countries (market dynamism on
the vertical axis) and the extent to which exports
are growing in these countries (competitiveness on
the horizontal axis) (12). The graph shows that the
UK's top export destinations are disproportionally
represented in the bottom-left quadrant of the
(10) A destination country is 'dynamic' if its total imports grow
faster than world total imports.
(11) In terms of relative growth rates of imports.
(12) The size of the bubble indicates the weight of a destination
on total exports of the UK.
17
3. Imbalances and Risks
Box 3.1: The Financial and Insurance services sector
The UK financial and insurance services sector has experienced adverse developments in the last 5
years. Its gross value added (GVA) reached a peak of 10.7% of GDP in 2009, but fell to 7.9% of GDP in
2012 – a lower share than in 2005. It remains, however, well above the Euro Area 12 average (graph 1a).
The shrinkage of the sector, which contributed substantially to growth in the previous decade, could have
important repercussions for the UK economy. While in 2000-08 financial services (excluding life insurance)
contributed on average 23% of total corporation tax receipts, this fell to approximately 13% in 2012-2013
(1). The proportion of UK workforce which is accounted by the sector declined from 4.6% in March 2009 to
4.2% in March 2013, accelerating the downward trend since 1995. Rising GVA and falling employment
were among the main contributing factors to increased productivity in the UK in the decade until 2009. The
financial sector contributes to the surplus in services trade of the UK. The degree to which the sector can
recover and increase its contribution to the trade balance has a significant impact on the economic prospects
of the country.
There are signs that the export performance of the sector will improve with global economic recovery.
This is most visible in the divergent developments in London (2), which accounted for 52% of financial
sector GVA in 2011, and the rest of the UK. Graph 1b shows that income of financial and insurance
activities taking place in London stayed flat in 2009-2011, while it fell strongly in the rest of the UK. Since
London-based financial firms have a higher propensity to export than in the rest of the country, most likely
focused on retail banking, this bodes well for the prospects of financial services exports. It is indicative,
however, of the depth of the issues facing the retail banking industry outside the capital and consistent with
the reported difficulties of SMEs to access finance. However, there are indications of a gradual recovery in
the sector. Net receipts (3) from the banking sector which had decreased substantially to less than GBP 18
billion in 2008-10 from GBP 23 billion of 2007-08 have started to climb again to above GBP 20 billion
since 2010-11; this is a strong rise taking into account that this includes the GBP 1.6 billion from the
introduction of the Bank Levy - an annual tax on certain equity and liabilities of banks, building societies,
banking and building society groups. The financial sector remains therefore in a position that would allow it
to contribute to export growth significantly as the global economy recovers.
(1) HM Revenue and Customs
(2) NUTS 2 statistical region Greater London
(3) PAYE, Bank Payroll Tax, Corporation Tax and Bank Levy
18
3. Imbalances and Risks
Over the medium term, geographical
specialisation might diversify continuing a
rebalancing away from the EU to emerging
markets (Graph 3.7). While the EU is still the main
export destination for goods, accounting for half
the trade in value, the share of BRICs in total
exports has grown from 4.9% in 2006 to 9.6% in
2012.
and deterring imports – which become more
expensive for domestic purchasers - however,
there may be circumstances in which a
depreciation is less effective than expected (13).
Graph 3.8: Exchange rate developments
1.6
1.5
EUR/GBP
Graph 3.6: Dynamism and competitiveness of goods
export
4
Switzerland
2
China
Market Dynamism (pp)
0
USA
-2
Netherlands
Belgium
-4
Germany
1.4
1.3
1.2
1.1
Ireland
-6 France
1
-8
Italy
Spain -10
04
05
06
07
08
09
10
11
12
13
Source: Commission Services
-12
-10
0
10
20
30
40
Competitiveness (pp)
Source: COMTRADE data (HS 1992 Commodity Classification),
Commission Services
Graph 3.7: Export destinations, goods
50
40
Export growth may have responded by less
than expected to the fall in the exchange rate
because, following the depreciation, prices may
have risen relative to those of foreign
competitors, thus eroding the competitive
advantage that may normally be expected. It is
noteworthy that the export price deflator has risen
by more than that of the Euro 15 (Graph 3.9).
30
%
Graph 3.9: Deflator of exports
135
20
130
125
0
02 03 04 05 06 07 08 09 10 11 12
Germany
Rest EU
Rest World
Netherlands
BRICS
Source: Office for National Statistics
index 2005=100
10
120
115
110
105
100
95
90
05
3.1.3. The impact of the depreciation
Sterling fell significantly vis à vis the euro
between 2007 and 2009. It is now at a mean of
approximately 1.2 euro from a 4-year pre-crisis
average of almost 1.5 euro (Graph 3.8). The
depreciation could be expected to improve external
competitiveness and the current account balance,
the impact on the latter by boosting exports –
which become cheaper for foreign purchasers –
06
07
08
EU 15
09
10
11
12
13
UK
Source: Commission Services
The strong nominal depreciation in 2008 is
matched by a marked fall in the real effective
(13) For example, Bahmani et al (2013) show that a devaluation
may be less effective than might be supposed in its effect
on a country's competitive position. Although for some
sectors there may be an improvement in net exports, for
many others there is not, and it is not clear a priori which
sectors will react positively.
19
3. Imbalances and Risks
exchange rate (REER) (Graph 3.10) (a standard
measure of competitiveness). The close
relationship between the REER and the nominal
effective exchange rate (Graph 3.11) reflects the
relatively small impact of relative inflation to
changes in competitiveness since the depreciation
in 2008.
10
Graph 3.10: Decomposition of REER
terms by 7% compared with that in the EU 15 of
14%.
It is likely to be the case that exporters have
responded to the depreciation by increasing
margins rather than significantly expanding
output (Graph 3.9). In addition, nominal unit
labour costs have risen consistently since 2008
(Graph 3.12) as growth in nominal compensation
has continued, albeit at a subdued rate, but labour
productivity has fallen.
Graph 3.12: Unit labour costs and its components
0
115
110
-5
105
2008=100
Rate of change y-o-y (%)
5
-10
100
95
-15
90
99
01
03
05
07
09
11
13
NEER IC-42
relative HICP (-)
REER (HICP) IC-42
REER (ULC) IC-37
85
08
09
10
Nominal wage
Source: Commission Services
11
Productivity
12
13
ULC
Source: Commission Services
110
Graph 3.11: Nominal effective exchange rate
(NEER)
105
index, 2005=100
100
95
90
85
80
75
70
65
60
05
06
07
08
09
10
11
12
13
Source: Commission Services
Since 2008, the sizeable depreciation has not
had a significant relative impact on export
growth or the contribution to growth from net
exports. Although goods exports grew between
the trough in 2009 and 2013 by 21% - broadly in
line with that in the EU 15 of 24% - services'
exports remain relatively subdued, growing in real
20
A sectoral assessment suggests that, between
2009 and 2011, firms in the tradable sectors,
specifically in the manufacturing sector, may
have benefited from the depreciation of sterling
(Graphs 3.13a and b) (14). Higher margins may
have improved the relative profitability of
tradables compared to non tradables which might
provide incentives to firms in the tradable sector to
allocate more resources in the production process.
In the pre-crisis period, profitability in the non
tradables (in particular construction and real estate)
did not rise above that of other sectors, as it did in
certain other large EU Member States (Graph
3.13a).
(14) Chapter II.2 in the Product Market Review 2013 European
Commission (2013g) explores the capital allocation
process between tradable and non-tradable sectors in terms
of incentives and constraints using firm-level data.
3. Imbalances and Risks
7
2009. Government policy may help address
bottlenecks to exports as discussed in the
following subsection by helping to raise
productivity and competitiveness.
Graph 3.13a: UK firm-level Return on Assets, industry
medians
6
5
3.1.4. Policy responses: Infrastructure, skills and
SME finance
%
4
3
Previous IDRs identified structural constraints
in infrastructure, skills and access to finance
that might affect export performance especially for SMEs. There are policies in place to
address these bottlenecks. Moreover, the
government has an ambitious objective to "double
the UK’s exports to GBP 1 trillion by 2020 and a
program to attract more inward investment in UK
infrastructure projects" (16). However, there are
challenges relating to detail and delivery.
2
1
0
03
7
04
05
06
07
08
09
10
11
Graph 3.13b: France, Italy and Spain firm-level Return
on Assets, industry medians
6
5
Infrastructure
%
4
3
2
1
0
03
04
05
06
07
08
09
10
Construction and real estate
Other services
Manufacturing
Trade and transport
11
Source: ORBIS
However, increased profitability has not
resulted in a significant increase in exports as
discussed above. It may also be the case that
demand from major trading partners for exports
fell during the international economic crisis –
although that impact should unwind as the crisis
recedes. In addition, the price elasticity of demand
for high value exports is likely to be low because
demand may depend on non price as well as price
characteristics. In addition, resource allocation
towards the export sector could also be affected by
uncertainty as to whether the fall in the exchange
rate is temporary or permanent – although this
effect should have receded by now ( 15).
Investment in infrastructure is below the EU
average (17). Investment in transport infrastructure
are particularly relevant (Graph 3.14) - in the last
decade, the UK has invested less in transport
infrastructure as share of GDP than the EU27
average and countries - such as France and
Belgium – which, like the UK, have a mature
transport network. Moreover, the investment share
in GDP has fallen over time, similar to the trend in
Germany, but the fall has become more
pronounced since 2009. In an advanced economy,
adequate investment in infrastructure – while not
sufficient in itself – may be a pre-condition to
enhancing export performance; recent research
indicates a positive association between domestic
transport infrastructure improvements and small
and medium-sized firms' probability of exporting
(18).
(16) UK government (2013a).
(17) European Commission (2013c).
(18) Albarran et al. (2013).
Government policy can play a role in improving
the environment in which exporters operate,
facilitating rebalancing over the medium term.
As noted above, productivity has declined since
(15) Firm-level data also shows that investment rates in
tradables are, at best, reaching their pre-crisis levels.
21
3. Imbalances and Risks
Graph 3.14: Transport gross investment spending
(exluding maintenance)
1.2
% of GDP
1.0
0.8
0.6
0.4
0.2
0.0
00 01 02 03 04 05 06 07 08 09 10 11
EU27
BE
FR
DE
UK
Source: Commission Services
There are also concerns about the quality of the
infrastructure. A survey by the World Economic
Forum shows a relatively low assessment of the
quality of infrastructure in the UK, as well as a
relatively low assessment of the quality of roads.
Perceptions from abroad about the quality of
infrastructure are, however, mixed. For example,
according to a survey of foreign-based companies
(19), 81% of respondents acknowledged transport
and logistic infrastructure as a good reason to
invest in the UK and 89% of respondents praised
technology and telecommunications infrastructure
– which is consistent with the fact that the UK has
an above EU average percentage of broadband
lines with speed above 10 MBps (20).
London's economic success risks exacerbating
the regional divide within the UK. A large rail
project, High Speed 2, initially planned to run
between London and Birmingham, has the
potential to change regional dynamics but its
potential impact is ambiguous: on the one hand it
will make London easier to reach and thus increase
the attractiveness of siting business in London but,
on the other hand, it will allow easier access to
Birmingham and other regional centres from
London. A further option to enhance growth
outside London could be to enhance connectivity
between cities in northern England (Manchester,
Newcastle, Liverpool), as well as between
different parts of the UK.
(19) Ernst & Young (2013).
(20) Besides infrastructure, the UK holds Foreign Direct
Investment's leadership in Europe – measured by number
of new projects - and further market research finds that
foreign investors’ perceptions of the UK’s labour skills,
employment costs, transport infrastructure and corporate
taxation are of world-class and have all improved recently.
22
The government has announced an ambitious
infrastructure program and has published a
'pipeline' of infrastructure investment worth
GBP 375 billion between 2015 and 2020 (21).
GBP 100 billion of infrastructure investment is
expected to be funded publicly while the
remaining GBP 275 is expected to be raised from
private funds – for instance a group of large
insurance companies has agreed to invest GBP 25
billion in the 5 years from 2014 (22). The National
Audit Office (23) has, however, expressed concerns
about how the private financing might impact on
consumers , who will eventually be charged higher
tariffs, especially those on low incomes. Most of
the value of the pipeline is in the energy and
transport sectors, worth over GBP 340 billion of
combined investment.
There are inherent risks in the private sector
element of the financing – which accounts for
around three-quarters of the total financing; in
particular, the degree and timelines in which
the private financing will materialise. While
anecdotal evidence suggests that investment in
infrastructure could be considered attractive by
institutional investors, and that business networks
may welcome even larger investment plans,
greater detail and clarity is required on the
composition of the private financing and
reassurance that the required amount of that
finance will materialise.
Potential investors in infrastructure include
international investors (e.g. sovereign wealth
funds) and domestic investors (pension funds).
The Pensions Institute has forecast that the defined
contribution pension schemes’ auto-enrolment
market will increase to GBP 1680 billion (24) of
assets under management by 2030. The extent to
which those assets will be invested in
infrastructure is linked to the concentration of
pension funds, as in an overly fragmented market,
individual funds might lack scale for such large
investments. A solution may be provided by
platforms that pool the resources of more pension
funds for infrastructure investment – such as one
recently announced by the National Association of
Pension Funds (25). Nevertheless, there remains a
(21)
(22)
(23)
(24)
(25)
HM Treasury (2013b).
UK government (2013b).
National Audit Office (2013).
Pensions Institute (2013).
National Association of Pension Funds (2013).
3. Imbalances and Risks
need for greater detail on the infrastructure
investment plans in relation to the source,
composition and timing of funds
Further risks to delivery of the infrastructure
programme include alleged uncertainty in the
regulatory environment – for example - the
Confederation of British Industry’s infrastructure
survey (26) identified planning as the biggest
constraint (96%) for infrastructure investment. The
fact that the delivery of the projects is spread over
a number of years is a further element of risk.
Skills and job matching
The 2012 and 2013 IDRs identified a gap in
skills, in particular, there are an insufficient
number of workers with intermediate vocational
training. While the skills base is strong overall,
there is room for improvement in basic and
intermediate skills. It is noteworthy that, compared
to the EU average, the UK has a larger number of
early leavers from education and training.
International comparisons (27) also show a
relative underperformance in attainment in
basic skills and foreign languages. Although
English is the global language of business,
knowledge of foreign languages by UK citizens
could increase their ability to participate in
international trade and boost international
mobility; to eventually facilitate this, it is a
positive development that language classes in
schools will be made compulsory (28) for pupils
from the age of 7 in England.
On the positive side, employers are generally
satisfied with skills availability (29). The UK has
a high share of adults between 30 and 34 of age
with tertiary educational attainment (30) and a
relatively high employment rate of graduates.
Higher education provides additional reasons to be
optimistic:
universities
are
internationally
renowned and could be a driver of regional
rebalancing. In fact, the creation of clusters of
firms which exploit the specialisations of
universities outside London could create attractive
(26) Confederation of British Industry (2013).
(27) OECD (2013a), OECD (2013b), McKinsey (2013).
(28) Schools can fulfil the requirement by offering either
ancient or modern languages.
(29) McKinsey (2013).
(30) European Commission (2013b).
jobs in different cities and counteract the
centripetal force that brings graduates to London.
The demand for skilled labour is likely to
increase as soon the economy recovers. This
would be a positive development for the economy,
as, according to OECD, the UK (31) has been more
effective in providing opportunities to their more
highly skilled adults than many other countries.
Nevertheless, the problem of the vertical skills
mismatch in the UK might have worsened after
2008. While graduates usually do well in the
labour market, according to the Office for National
Statistics, the percentage of graduates working in
non graduate roles has risen, particularly since the
2008-2009 recession. This suggests that the
increasing supply of graduates and the possible
decrease in demand for them has had an effect on
the type of job they undertake (32). Since new
graduates could not be absorbed into the labour
market to the same extent as previously, some may
have to 'down-skill'. To address the situation,
promotion of STEM subjects (science, technology,
engineering and mathematics) in higher education
may assist.
Job matching efficiency has recently worsened,
in particular, for long-term unemployed. This is
suggested by the Beveridge curve, which depicts
the relationship between unemployment and job
vacancies. The curve is usually downward-sloping:
economic upswings are characterised by low
unemployment and many vacancies and vice versa
in downturns. Shifts of the curve are departures
from the usual downward-sloping trajectory and
may indicate structural changes in the labour
market. An outward shift of the Beveridge curve is
an indication of a deterioration of job market
matching.
The Beveridge curve showed little movement in
the years before 2008 (Graph 3.15a) (33) which
can be explained by the fact that the economy then
operated at high factor utilisation, low
unemployment and a relatively high vacancy rate
(the number of vacant posts as a percentage of
total posts, vacant or occupied). As the
international economic crisis unfolded, vacancies
(31) The survey covered England and Northern Ireland.
(32) Office for National Statistics, 2013.
(33) The analysis is based on European Commission (2013e).
23
3. Imbalances and Risks
fell and unemployment increased to levels where it
remained until the last quarter of 2012, the last
observation available.
Graph 3.15a:Beveridge curve - pre- and post-crisis
Source: European Commission (2013)
Graph 3.15b:Beveridge curve - by duration of
unemployment, after 2008
Source: European Commission (2013)
A large majority of unemployment is shortterm (shorter than 12 months in duration).
Graph 3.15b depicts the post-crisis Beveridge
curve in the UK by duration of unemployment (34).
It shows that the short- and long-term Beveridge
curves have a different pattern. The Beveridge
curve corresponding to short-term unemployment
is characterised by the usual downward-sloping
pattern. By contrast, the Beveridge curve
corresponding to long-term unemployment
exhibits an outward shift of about 1 percentage
point in 2009-2010, presumably about 12 months
(34) The Beveridge curves corresponding to short and long term
unemployment exhibit the same movement along the Yaxis, as the vacancies are not specific to the duration of
unemployment.
24
after the first wave of dismissals during the crisis),
and did not increase further after 2010. It appears
that a large part of unemployment remains
cyclical, and a smaller, albeit rising, part
potentially structural (Graph 3.15b). Short-term
unemployment could be expected to decrease as
the economy moves along the short-term
Beveridge curve.
The government intends to address the shortage
of intermediate skills. The government published
"The Future of Apprenticeships in England:
Implementation Plan" in October 2013 (35). This
was a response to the 2012 Richard Review (36), an
independent report on improving the quality of
apprenticeships. Apprenticeships are to be based
on standards designed by employers in order to
better meet the needs of the economy. These
standards, which will replace the current
frameworks, aim to simplify the system. In relation
to quality assurance, the government will set a
small number of criteria: apprenticeships will be
required to last at least 12 months; off-the-job
training will continue to be a requirement of all
apprenticeships
and
English and
maths
requirements will be stepped up gradually.
Implementation will be completed by 2017-18.
Compared to that in 2011-12, the number of
apprenticeship starts at advanced level and
higher level has increased, while apprenticeship
starts at intermediate level decreased. This may be
a first sign of a rebalancing of apprenticeships
towards higher skill levels. Ongoing reforms of
vocational qualifications are also part of the effort
to increase vocational skills among young people
and adults.
Policy initiatives to raise vocational skills are
likely to be beneficial if maintained, or even
stepped up. Indeed, skills forecast expect an
increased demand for medium qualifications in the
UK. CEDEFOP, the European Centre for the
Development of Vocational Training, estimated
projections about employment trends by
qualification up to 2020. Compared with 2010, it
expects an 17.8% increase in jobs requiring
medium qualifications in the UK, much higher
than an EU average increase of 4.6%; a 20.6%
increase in jobs requiring high qualifications,
(35) HM Government (2013).
(36) Richard (2012).
3. Imbalances and Risks
broadly in line with an EU average increase of
19.1%; and a 42.9% decrease in jobs requiring low
qualifications, which is more pronounced than an
EU average decrease of 20.2%.
The effectiveness of policy responses to skills
shortages can be improved. According to the
Social Mobility and Child Poverty Commission,
the Youth Contract has not worked "effectively
enough" (37). There is anecdotal evidence that
business
associations
are
supportive
of
apprenticeships, provided that they are of high
quality and targeted at certifying relevant work
experience and skills.
Work is underway to increase the attractiveness
of vocational education as an alternative career
path, as currently there might be 'stigma' attached
to it, perhaps because of better perceptions
attached to academic education. The key to the
success of these policies is productive cooperation
with employers in the design and development of
occupational standards and skills profiles to make
vocational qualifications more attuned to labour
market needs (38). As young people are "not much
better equipped with literacy and numeracy skills
than those who are retiring" ( 39), there is also scope
for thinking strategically about the role of lifelong
learning.
Fine-tuning of immigration policies has the
potential to broaden the skills base of the UK. It
would make it easier to recruit experts from new
export destinations and UK employers would have
access to a larger pool of talent (40).
Access to finance for SMEs
International comparisons suggest that UK
SMEs have a lower export propensity than EU
peers (41). According to a recent survey ( 42), only a
minority of SMEs (14%) were internationally
active. Of all survey respondents, 8% reported
(37) Social Mobility and Child Poverty Commission (2013).
(38) See UK Commission for Employment and Skills (2013).
(39) OECD (2013b) shows that England is the only country
where adults aged 55-65 perform better than 16-24 year
olds in both literacy and numeracy.
(40) In addition, migration could be good for the economy as a
whole. Dustmann and Frattini (2013) show that immigrants
to the UK have made a positive fiscal contribution between
1995 and 2012.
(41) See European Commission (2010).
(42) BDRC (2013).
having exported while 11% reported having
imported in the third quarter of 2013.
A constraint on the decision of SMEs to export
may be an inability to easily obtain access to
external finance. SMEs can potentially benefit
from the significant depreciation of sterling that
took place since 2008. However, difficulties
accessing finance, particularly credit, and/or
accessing it on competitive terms, may constrain
SMEs' ability to expand and access export
markets (43). It may also affect their ability to
compete
internationally
by
constraining
productivity (44).
The ability of SMEs to raise external finance
appears to have been impaired during the
global financial crisis and subsequent UK
recession. As discussed in Box 3.3, PNFCs as a
whole were excessively reliant on credit as a
source of finance in the lead-up to the international
economic crisis and recession in the UK and have
been adversely affected by the continuing decline
in bank credit, not least because they have been
unable to obtain external finance by alternative
means. The reliance on external credit to expand is
likely to be a particular issue for SMEs which can
lack the size or sophistication to issue fixedinterest debt and equity or seek other means of
external finance and are mostly reliant on bank
credit to raise funds.
Neither credit available to SMEs nor their
perceptions of their ability to access credit have
improved significantly since the 2013 IDR. Net
lending to PNFCs, and to SMEs in particular,
continued to decline in 2013 (Graph 3.16). In
addition, surveys of SMEs continue to show that
access to finance on suitable terms remains a
concern. According to BDRC Continental's SME
Finance Monitor, more than a third of SMEs
applying for a loan did not manage to obtain the
desired facility either because they were turned
down or because of other issues with the 'offer'
(43) European Commission (2013a) finds that access to finance
is reported as the third most pressing problem for UK
businesses (15.4%, equal to the EU average).
(44) See European Commission (2013f) for evidence on how
difficulties accessing finance decreased the probability of
manufacturing firms becoming exporters in 2008 by
negatively affecting their productivity.
25
3. Imbalances and Risks
Graph 3.17: Corporate credit costs by firm size
60
Decreased costs
50
40
30
20
10
0
-10
-20
-30
Small
Large
Spreads on loans
Source: Bank of England's Credit Conditions Survey and Bank
of England calculations
Graph 3.16: Lending to UK private non-financial
corporations
7
20
Graph 3.18: Lending to UK private non-financial
corporations
6
15
10
5
5
4
0
%
1
Source: Trends in Lending April 2012 (Bank of England, British
Bankers' Association and Department for Business Innovation and
Skills) for data up until February 2012; Bank of England for data from
April 2012 onward.
0
Note: the private NFC and SME series are subject to a break in March 2012 due
to a new data collection by the BoE; the small businesses series was terminated
Not only does credit supply remain constrained,
the cost of credit is comparatively high for
SMEs. Survey evidence suggests that borrowing
cost developments since 2009 have been more
unfavourable for smaller companies than for larger
ones (Graph 3.17). Although the cost of borrowing
declined when the Bank of England cut its
reference rate to 0.5% in 2008, margins have risen,
particularly for smaller SMEs (Graph 3.18). The
relatively high margins may be partly explained by
the risk characteristics of SMEs but, nevertheless,
(45) BDRC Continental (2013). Survey results refer to loan
applications made between the second quarter of 2012 and
the third quarter of 2013.
(46) Federation of Small Businesses (2013).
(47) See Monteiro (2013) for a review of survey evidence.
(48) Business Bank Advisory Group to the Department of
Business Innovation and Skills (2013)
May 13
Bank Rate
11
12
13
Small Businesses
Nov 12
10
May 12
08
09
All SMEs
Nov 11
07
Smaller SMEs
All SMEs
Nov 08
04
05
06
Private NFCs
Medium SMEs
2
May 11
-15
3
Nov 10
-10
May 10
-5
Nov 09
y-o-y % change
Medium
Fees and commissions on loans
25
26
09Q4
10Q3
11Q2
12Q1
12Q4
13Q3
10Q2
11Q1
11Q4
12Q3
13Q2
10Q1
10Q4
11Q3
12Q2
13Q1
-40
May 09
30
may remain a deterrent to SMEs requiring costeffective finance in order to expand.
Increased costs
(45). Additionally, 17% of applicants managed to
obtain funding only after going through issues with
the offer. Another recent survey carried out by the
Federation of Small Businesses in the fourth
quarter of 2013 showed that approximately four in
10 ten SMEs applying for loan had been
unsuccessful (46). These comparatively high loan
rejection rates have been a persistent characteristic
of the post-crisis period in the UK ( 47). A recent
report to the UK government (48) estimated a
funding gap for SMEs of GBP 8.2-12.6 billion in
2012. The size of the gap was split reasonably
equally between 'loan rejections' and 'discouraged
demand' (that is, SMEs that did not consider it
worthwhile to apply for a bank loan to begin with).
Finally, bank lending to SMEs is relatively
concentrated which may render them particularly
dependent on the relationship established with
their own bank (see Section 3.1.12).
Source: Department for Business Innovation and Skills
Note: Interest rates are indicative medium rates on new SME
variable-rate facilities.
The government has responded to concerns
surrounding SME access to finance with a
number of measures. These include inter alia, the
Funding for Lending Scheme designed to boost
credit availability and reduce the cost of borrowing
for firms, including SMEs; the proposed Business
Bank, to provide alternative sources of finance to
SMEs. (These measures are discussed in the
following section.) While a number of access to
finance policies have been in place for a significant
period of time, they nevertheless have yet to exert
a marked impact on SMEs' credit conditions.
3. Imbalances and Risks
3.1.5. Conclusions
The UK's export share in world exports
continues to decline but the pace is less rapid
than in previous years. This continues the pattern
of gradual but persistent decline of the past decade.
There is no apparent single reason to explain the
decline; rather, it is likely to be the outcome of a
number of smaller factors and wider issues relating
to the structure of exports and its export markets.
Such trends need to be interpreted in the context of
the rising share of emerging markets in world
trade.
Government policies could support a
rebalancing towards net exports. For example,
the effective delivery of the announced 'pipeline' of
infrastructure investment has potential to remove
bottlenecks and boost export performance. In
addition, the focus on apprenticeships is likely to
raise skills provided that the quality of the
apprenticeships is high. The authorities could also
continue to monitor the impact of credit access and
export finance policies and extend them if
necessary.
Overall, the declining export share is unlikely to
pose short-term risks to the economy. However,
in the absence of a major change in the structure of
exports or export markets, or government policy to
support rebalancing, the export share is likely to
continue to slowly deteriorate over the medium
term. In turn, the main risk associated with a slow
deterioration of the export share is, other factors
held constant, an associated deterioration, over the
medium term, of the current account deficit and
the net international investment position.
27
3. Imbalances and Risks
3.2.
PRIVATE SECTOR INDEBTEDNESS
250
200
Developments in the housing market and
household sector indebtedness have been
particularly marked over the past year and have
potential implications for the existence of, and
risks surrounding, any macroeconomic imbalance
and are analysed separately in Section 3.3.
3.2.2. Trends and developments
Size of deleveraging
After having increased steadily during the
previous decade, private sector indebtedness
has peaked at 195% of GDP (49) in 2009 (Graph
3.19). Since then, private sector indebtedness has
fallen to 179% of GDP in 2012 reflecting
deleveraging by households and PNFCs as the size
of the economy grew in nominal terms. However,
the pace of reduction in indebtedness declined in
2012 – as minimal economic growth was matched
by a small fall in debt holdings.
(49) All data is quoted on a consolidated basis unless otherwise
indicated.
28
% of GDP
3.2.1. Introduction
High private sector indebtedness was identified
as a macroeconomic imbalance in the IDRs in
2012 and 2013 and has been identified again as
a potential imbalance in 2014. This section
analyses: recent trends and developments in
private sector indebtedness, risks associated with
high levels of private sector indebtedness,
particularly
for
Private
Non-Financial
Corporations (PNFCs), the need to maintain
adequate access to finance, especially for SMEs
while orderly deleveraging continues, the impact
of government policy in facilitating sufficient
access to credit and sets out conclusions on the
state of any imbalance and the risks associated
with it.
Graph 3.19: Households' and PNFCs'
indebtedness
150
100
50
0
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12
Households
Non financial corporations
Private sector EA17
Private sector
Source: Commission Services
Private sector indebtedness is, broadly, split
equally between indebtedness of households and
PNFCs (Graph 3.19) and the pace at which both
sectors reduced holdings of debt fell in 2012:
 for PNFCs', debt as a % of GDP has fallen
since its peak in 2009 but the pace of decline
lessened in 2012 as PNFCs' debt began to
stabilise at a relatively high level; and
 for households, debt as a % of GDP has also
fallen since its peak in 2009 and the pace of
decline lessened in 2012 as debt also began to
potentially stabilise at a relatively high level.
Despite recent falls, the current level of private
sector indebtedness remains historically high.
Alternative
measures
of
indebtedness
corroborate the slowdown in deleveraging by
the corporate sector: PNFCs' debt as a % of gross
operating surplus has fallen from the peak of 2009,
although the pace of decline slowed in 2012
(Graph 3.20) and corporate debt as a % of financial
assets and corporate debt as a % of total assets (or
gross wealth) have also fallen but the decline has
slowed more recently (Graph 3.21).
Graph 3.20: PNFCs' debt as percentage of
gross operating surplus
% of GDP and assets
700
650
%
600
550
500
180
Graph 3.22: Household debt as a percentage of gross
180
disposable income
160
160
140
140
120
120
100
100
80
80
60
60
40
40
20
20
% GDI
3. Imbalances and Risks
450
0
0
96
400
04
05
06
07
08
09
10
11
98
00
02
04
06
08
10
12
Debt / GDP, Households
Debt / fin. assets, Households
Debt / gross disposable income, Households (right axis)
12
PNFCs' debt as percentage of ross operating surplus
Source: Commission Services
Source: Commission Services, Office for National Statistics
Ratios of debt to equity, GDP and total assets
(%)
Composition of deleveraging
Graph 3.21: Measures of PNFCs' leverage
120
100
80
60
40
20
The composition of deleveraging since 2008 has
differed between households and PNFCs (Graph
3.23). For PNFCs it has been achieved,
predominantly, by reductions in gross borrowing
and, to a lesser extent, write offs on loans. By
contrast, for households, the greatest contribution
to deleveraging has been a rise in nominal
disposable income – a relatively minor role has
been played by write offs and, in absolute terms,
the level of borrowing has actually increased.
0
96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13*
Debt / GDP
Debt / assets
Debt / equity
Debt / assets, consolidated
Source: Commission Services
The pace of deleveraging by the household
sector has also slowed. Trends in household debt
as a percentage of financial assets and household
debt as a percentage of total assets (or gross
wealth) indicate that household deleveraging has
slowed recently and that it has plateaued at a
relatively high level (Graph 3.22).
Graph 3.23: Composition of household
deleveraging
10
0
-10
-20
-30
-40
-50
UK household sector
UK corporate sector
Borrowing
Write-offs on loans
Change in debt to income
Source: Bank of England
Broadly, there are five possible drivers of
deleveraging (50): increased economic growth,
increased saving, increases in inflation, 'financial
repression' and debt restructuring. The preferred
option to facilitate deleveraging is an increase in
GDP growth. However, this has not, to date, been
(50) See European Commission (2013h).
29
3. Imbalances and Risks
During deleveraging, households' consumption
rose less than disposable income. As a result the
household saving ratio rose (Graph 3.24). In 2012
and 2013 the gap between the two narrowed
somewhat as the saving ratio stabilised (Graph
3.25). For PNFCs, the pattern has been different:
gross operating surplus has risen only slightly
while business investment has fallen sharply.
Graph 3.24: Gross operating surplus and
household gross disposable income
110
3.2.3. Credit supply
The stalling in the pace of deleveraging has
been accompanied by divergent trends in credit
supply. The experience of households and PNFCs
noticeably differs: increases in credit supply to the
household sector increased in late 2012 – and, in
particular, growth in unsecured credit has been
relatively brisk - and grew further in 2013 but
credit supply to PNFCs continued to decline
throughout this period (although the pace of
decline slackened). For PNFCs, credit supply has
fallen more heavily for SMEs than for PNFCs
overall (Graph 3.26).
Graph 3.26: Credit growth by sector
25
Year on year %
the predominant route by which PNFCs have
deleveraged (51) – rather, deleveraging has been
achieved largely through a reduction in borrowing
- and, therefore, may have impacted adversely
upon future economic growth by more than would
have been the case if it had been achieved through,
for example, an increase in gross operating
surplus. It may also explain the subdued
performance of business investment vis a vis
household consumption (Graph 3.25).
20
15
10
5
0
-5
-10
Jan 07 Jan 08 Jan 09 Jan 10 Jan 11 Jan 12 Jan 13
08Q1=100
100
90
60
08
09
10
11
12
13
Households gross disposable income
Gross operating surplus (PNFCs)
Household consumption
Business investment
Source: Office for National Statistics
Graph 3.25: Household saving ratio
8
7
% disposable income
To PNFC's
Individuals, secured
Individuals unsecured
To SMEs
To SMEs, new series
Source: Office for Budget Responsability
80
70
6
The reasons for the significant rise in growth of
household unsecured credit may reflect
increases of purchases of large items such as
cars. More broadly, growth in demand for
unsecured credit may reflect the boost in economic
sentiment and confidence associated with the
return to growth. For example, consumer
confidence as measured by the GfK Survey has
picked up steadily throughout 2012 and 2013 (52)
(Graph 3.27), amidst rise in expected income
growth and a loosening of credit conditions so that
unsecured credit is more easily available than in
the previous three years.
5
4
(52) GfK UK Consumer Confidence Measures December 2013.
3
2
1
0
00 01 02 03 04 05 06 07 08 09 10 11 12
Source: Commission Services
(51) See Cuerpo et al (2013).
30
To individuals
3. Imbalances and Risks
Box 3.2: PNFCs - supply and demand for credit.
The reduction in the availability of credit can be examined from the supply and demand sides (1).
Graph 1b: Attractiveness of different sources
of corporate funding
Graph 1a: Perceived riskiness of future
investment opportunities
50
25
0
60
40
20
%
-25
-50
-75
-100
07
08
09
10
11
12
Is this a good time to be taking greater risk onto your balance
sheets?
How would you rate the general level of external financial and
economic uncertainty facing your business?
Do you think UK corporate balance sheets are over leveraged?
13
Unacctractive
%
80
Attractive
75
0
-20
-40
-60
-80
07
08
09
Bond issuance
10
11
12
13
Equity issuance
Bank borrowing
Source: Deloitte CFO Survey
Source: Deloitte CFO Survey
Demand side factors
Larger PNFCs (2) may have reduced their demand for credit. For example, the perceived riskiness of
investment opportunities may have increased thus deterring demand although while there is some evidence,
overall it is mixed (Graph 1a). In addition, the attractiveness of raising finance by equity and bonds may
have risen increased relative to that of bank loans although again the evidence is mixed – while bonds may
have been increasingly perceived as a preferred source of funding, that is less likely to have been the case
for equity (Graph 1b). Moreover, given the depth of the downturn in growth in 2008-12 and its uncertain
aftermath, it is reasonable to expect that PNFCs' expectations for future growth fell.
It is a consistent theme of PNFCs' responses to surveys on demand for credit that they are unable to
obtain the amount of credit that they ideally desire and at an acceptable price. The outcome is
particularly marked for SMEs. While there may be a reduction in demand for credit there remains,
nevertheless, clear survey evidence of unmet demand for credit.
Supply side factors
Risk perceptions of PNFCs
Risk perceptions may be related to asymmetric information between the finance provider and PNFC – eg in
relation to its creditworthiness and future performance. A rise in risk aversion may result in a credit provider
being reluctant to provide funds without any track record and/or collateral to mitigate the risk of default.
An increase in negative risk perceptions towards PNFCs may have adversely affected the supply of credit;
write off rates on lending to PNFCs have increased somewhat since 2009 (Graph 2a). However, write-off
rates have fallen sharply since 2011 (although they remain high). In addition corporate insolvency rates have
declined since the recent peak in 2009 and also remain low. This suggests that the influence of risk
perceptions on supply may begin to wane.
(1) The analysis in this box is taken from Monteiro, D. (2013).
(2) The source for Graphs 1a and b is the Deloitte's survey of Chief Finance Officers of the top 350 companies listed on
the FTSE. As such, it does not cover the borrowing pattern of SMEs.
(Continued on the next page)
31
3. Imbalances and Risks
Box (continued)
Graph 2b: Changes in core Tier One capital
ratios and risk-weighted assets
Graph 2a: Write off rates for lending to PNFCs
1.8
14
1.5
12
1.2
10
%
0.9
0.6
8
6
0.3
4
0.0
2
91
93
95
97
99
01
03
05
07
09
11
13
Creditors' voluntary liquidations
0
France Germany
Italy
Spain
Compulsory liquidations
Receivership appointments
Administration appointments
Company voluntary arrangements
Sources: The Insolvency Service and Bank of England
2008
2009
2010
2011
United United
Kingdom States
2012
Source: SNL Financial, published accounts and Bank of
England calculations
Restoration of capital by the banking sector
The banking sector reduces the size of its risk-weighted assets and increase holdings of high quality
capital to meet strengthened regulatory requirements – which may have adversely affected credit
supply. The banking sector has substantially increased its core Tier One capital ratio and reduced its riskweighted assets. The capitalisation of the UK banking system now compares favourably with that of other
major countries (Graph 2b).
According to the Financial Policy Committee of the Bank of England (3), the banking system is
soundly capitalised and risks had been significantly reduced. While banks needed to raise more capital to
meet regulatory requirements, such amounts were small compared to those raised in the past few years.
Overall, the increased health of the banking system should support its ability to supply funds.
(3) Financial Policy Committee of the Bank of England (FPC). See Bank of England (2013e).
20
Graph 3.27: Economic sentiment and
consumer confidence
0
-20
-40
-60
3.2.4. Cost of credit
-80
-100
00 01 02 03 04 05 06 07 08 09 10 11 12 13
Consumer Confidence Indicator
General economic situation over last 12
months
Source: GfK and Commission Services
The reasons for the divergence in credit growth
between SMEs and PNFCs as a whole may
32
relate to certain characteristics of SMEs. This
issue is considered in more detail in Section 3.1.
However, credit supply for all PNFCs continues to
decline. Factors that may have influenced the
demand and supply of/for credit over 2009-13 are
discussed further in Box 3.2.
The cost of credit for PNFCs remained low in
2013. Having fallen steeply in late 2008 and 2009 coinciding with the reduction in the bank rate to
0.5 pps. - the cost of credit for PNFCs remained at
historic low levels throughout 2013 as shown in
Graphs 3.17 and 3.28.
3. Imbalances and Risks
Graph 3.28: PNFCs' cost of borrowing
percentage points
10
8
6
4
2
0
04
05 06 07 08 09 10 11 12 13
interest rate, other loans, new advances to PNFCs
interest rate, other loans, new advances on a
floating rate to PNFCs
interest rate, overdrafts
Source: Bank of England
3.2.5. Near-term outlook for credit supply and
demand
Recent survey results present a mildly positive
picture for corporate credit supply and demand
(53):
 corporate
credit
availability
increased
significantly in Q4 2013 for small PNFCs and
large PNFCs, although it was muted for
medium-sized PNFCs, and a further
improvement is expected in Q1 2014; and
 demand for corporate credit picked up further
in Q4 2013 for medium and large PNFCs
although it was subdued for small PNFCs, and
a further improvement is expected in Q1 2014
for small and large PNFCs.
3.2.6. Risks
Inadequate access to funds
and orderly (56). The potentially adverse impact of
deleveraging on growth and stability can be
mitigated if credit supply remains healthy.
Since the advent of the international economic
crisis, the supply of funds available to – and
raised by - PNFCs has fallen sharply. Prior to
the international economic crisis PNFCs were
disproportionately reliant on credit to raise funds
(Box 3.3). Since the crisis, PNFCs have been
unable to seek alternative sources of funds in large
quantities – and to the extent that they have raised
funds, it has been largely via equity issuance
although larger PNFCs have raised funds via bond
issuance. As has been discussed in previous IDRs,
PNFCs', and particularly SMEs', access to credit
was adversely affected by the weakness in the
banking sector as, in response to the international
economic and financial crisis and UK recession,
banks reduced the size of their balance sheets,
lowered lending to PNFCs and reduced risk as they
addressed capital shortfalls and strengthened
capitalisation ratios.
According to the 'Breedon Report' (2012) (57),
between 2012 and 2016 the projected 'financing
gap' for PNFCs could range from GBP 84-191
billion depending on GDP growth and its
relationship to credit supply. A continuing
inability to raise funds, through credit or
alternative means, is a risk for PNFCs –
particularly SMEs (SMEs' access to finance is
considered in more detail in section 3.1).
(56) See Cuerpo, C. et al (2013) which states 'credit conditions
are an important qualifying factor for deleveraging
processes and their assessment provides useful information
to better understand deleveraging pressures…..in short,
credit supply constraints….have a direct impact on nonfinancial sector deleveraging'.
(57) Breedon (2012).
Adequate access to funds is important if PNFCs
are to take full advantage of the projected
increase in growth in 2014 (54) to expand and/or
increase investment (55). Moreover, sufficient
access to credit during a period of deleveraging
can help ensure that such deleveraging is smooth
(53) Bank of England (2014), Credit Conditions Survey, 2013
Q4.
(54) See European Commission (2013a)
(55) There is also a link between adequate access to funds and
productivity. Evidence suggests that, in the euro area,
decreases in firm level productivity can be linked to credit
supply conditions See European Commission 2013(d).
33
3. Imbalances and Risks
Box 3.3: Sources of funds for PNFCs
Broadly, the main sources of funds for PNFCs are: bank credit, bond issuance and equity. Prior to
2009, PNFCs were heavily dependent on bank credit as the major source of funds prior to the international
economic crisis and UK recession (Graph 1a). Since then, fund-raising has been limited and below the levels
of the preceding decade. PNFCs have reduced credit holdings and relied on bond, equity issuance and
retained earnings to raise funds.
Graph 1b: Private bond market capitalisation in
G7 countries
140
40000
120
20000
% of GDP
100
0
-20000
80
60
40
13Q1
12Q1
11Q1
10Q1
09Q1
08Q1
07Q1
06Q1
05Q1
-40000
04Q1
4-quarter moving average, mGBP
Graph 1a: Sources of funds
60000
Other accounts receivable/payable, Credit
(resources/liabilities)
Unquoted shares and other equity, Credit
(resources/liabilities)
Quoted shares, Credit (resources/liabilities)
Loans, Credit (resources/liabilities)
Source: ECB
Securities other than shares, excluding financial
derivatives, Credit (resources/liabilities)
20
0
93
95
97
99
01
Canada
Germany
Japan
United States
03
05
07
09
11
France
Italy
United Kingdom
Source: World Bank's financial structure dataset 2013
While the UK is generally regarded as having deep and liquid financial markets (1) the experience of
the period since 2008 suggests that PNFCs' ability to raise funds is impaired. Credit supply has fallen
and continues to falls; far from raising funds through the acquisition of credit, in aggregate, PNFCs have
reduced their reliance on credit as a source of funds. Private bond markets in the UK have remained
relatively underdeveloped; this has been a long-standing feature of the funds market – so smaller PNFCs had
relatively little ability to switch from credit to bond issuance as a means to raise finance once credit market
conditions changed (Graph 1b). Although recourse to public equity is possible, PNFCs may not always wish
to list – it may not always be possible, or appropriate, particularly for smaller PNFCs which may be
unwilling to lose control and management freedom associated with equity finance. Moreover, the costs of
securing equity finance may be excessive and lack of knowledge of how to obtain it may be a deterrent.
(1) See World Economic Forum Global Competitiveness Report 2013-14. The Global Competitiveness Report ranks
countries on a number of measures including measures of access to financial services which include (the UK's rank is
in parentheses among EU 28): availability of financial services (1), affordability of financial services (3), financing
through local equity market (1), ease of access to loans (15) and venture capital availability (4).
High indebtedness of PNFCs in the propertyrelated sector
The composition of corporate deleveraging
varies significantly by type of firm according to
whether firms' business is predominantly
property related. As noted above, corporate
sector indebtedness has fallen by 17 percentage
points since its peak in 2009. However, while
loans to non-property firms have fallen by around
30% (GBP 57 billion) since 2008, that for core real
estate (CRE) firms has fallen by around 7% (GBP
29 billion) while that for property-related sectors
34
has fallen by 15% (GBP 14 billion) (Graph 3.29).
The indebtedness of these firms remains relatively
high while commercial property prices remain well
below their previous peak in 2007 – by around
40% in total and almost 50% for secondary
property (58).
(58) See Bank of England (2013a).
3. Imbalances and Risks
Graph 3.29: Stock of UK loans by sector a)
350
250
200
Graph 3.30: PNFCs' profitability ratios
50
150
25
45
100
0
98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13
% of value added
40
50
20
35
30
15
25
Gross entrepreneurial income
Gross operating surplus
Retained earnings (right axis)
Retained earnings, EA17 (right axis)
20
CRE companies
15
Non Property Related c)
10
Other Property related lending b)
5
5
Source: Bank of England
0
0
96
(a) Data show values of outstanding total lending by UK MFIs
excluding the effects of securitisations and loan transfers, and
excluding securities. Data are for lending in all currencies stated
in sterling terms. Data are not seasonally adjusted. From 2011
Q1, data are on the SIC 2007 basis. Changes in the SIC codes
have led to some components moving between industries.
(b) CRE includes the buying, selling and renting of real estate,
and the development of buildings.
(b) Other property related lending includes construction, hotels
and restaurants, and health and social work.
(c) Non property related lending includes agriculture hunting
and forestry, fishing, mining and quarrying, manufacturing,
electricity, gas and water supply, wholesale and retail trade,
transport, storage and communications, profesional services and
and support activities, public administation and defence,
education, and community service activities.
10
% of value added
Thousands GBP
300
that has continued in 2013 as growth in gross
operating surplus has outstripped that in gross
value added. In addition, a feature of the PNFC
sector that it is a net lender. This trend has
continued in 2012 and 2013.
98
00
02
04
06
08
10
12
Source: Commission Services
PNFCs' holdings of financial assets, including
cash, have risen sharply in the last ten years
(Graph 3.31). Moreover, PNFCs' loans to deposit
ratio has fallen sharply recently (Graph 3.32). The
rise in PNFCs' financial assets, including (near-)
cash holdings provides a counterweight to high
levels of gross debt and lessens the risks associated
with it.
Inadequate deleveraging by previously highly
indebted PNFCs
600
Aggregate trends may mask other differences
between PNFCs. The Bank of England (59)
discusses the extent of deleveraging by the type of
firm distributed by pre-existing levels of
indebtedness. It finds that the leverage of firms
that were already highly indebted has continued to
rise since 2008, in marked contrast to the least
indebted firms.
500
Graph 3.31: PNFCs' financial assets
% of GDP
550
450
400
350
300
250
200
Prudent PNFCs' balance sheets
00 01 02 03 04 05 06 07 08 09 10 11 12 13
Source: Office for National Statistics
The risks associated with high PNFCs'
indebtedness may be ameliorated by a
consideration of PNFCs' balance sheets and
profitability. Despite the weakness in the level of
gross operating surplus, profitability ratios remain
high (Graph 3.30). Measures of relative
profitability held up from 2009 to 2012 – a pattern
(59) See Bank of England (2013a).
35
3. Imbalances and Risks
Graph 3.32: Liabilities and Loans/Deposits Ratio,
Financial Corporations
50
Rate of change y-o-y (%)
total loans outstanding under the FLS were GBP
23 billion.
68
66
40
64
30
62
20
60
10
58
0
56
-10
% of currency and deposits
60
54
-20
-30
52
97
99
01
03
05
07
09
11
13*
Liabilities growth, Financial Corporations
Loans / deposits, Financial Corporations (right axis)
Source: Commission Services
Rising household unsecured lending
Although the rise in unsecured lending to
households is worth noting, it is unlikely to
constitute a major risk. Most importantly,
unsecured lending accounts for a small proportion
of households' debt (less than 5%) so is unlikely to
be of sufficient relative size to constitute a
macroeconomic risk. The vast majority of
household debt is secured. Growth in household
disposable income should continue in 2014-15 and
cushion the risks associated with high absolute
levels of household debt. Moreover, 'write off'
rates for unsecured lending have decreased sharply
since early 2010 and have now returned to the
rates preceding the international economic crisis.
3.2.7. Government policy – developments and
impact
The Government has instituted policies to improve
PNFCs' access to finance, in particular:
 the Funding for Lending Scheme (FLS); and
 the Business Bank.
The evidence to date on the impact of the FLS
on bank lending to PNFCs has been mixed. On
the one hand, it is difficult to disentangle the
impact of the FLS itself and international factors
that reduced wholesale bank funding costs inside
and beyond the UK since the middle of 2012. In
addition, the borrowing margin for PNFCs remains
low. Crucially, however, since the advent of the
FLS, lending remains muted and continues to fall.
Conceptually and practically, the FLS is a welldesigned policy; overall, however, it is yet to
significantly affect the supply of credit
outstanding to PNFCs. It may be that further time
is required for the FLS to have a significant impact
or it may be that, in the absence of the FLS, credit
availability would have been even lower – that is,
other factors are weighing down on lending. The
recent withdrawal of the FLS for loans for housing
(60) may lessen the likelihood of any 'crowding out'
of loans provided under the FLS for SMEs by
loans for households.
The Business Bank
The aim of the Business Bank, which is
expected to be operational by the second half of
2014, is to deploy capital to address gaps in the
provision of finance for SMEs. The Bank has
been provided with GBP 1.25 billion (61) of new
capital. In addition, a number of existing schemes
to support access to finance - of a total value of
GBP 2.4 billion – of both a debt and equity nature
- will be rolled into the Bank.
The capital provided to the new bank is
relatively small – however, it is expected that the
funds will be leveraged up with the addition of
private sector funds.
The Funding for Lending Scheme
The Funding for Lending Scheme (FLS) was
introduced in August 2012 by the Bank of
England. The aim of the FLS is to provide
incentives – by providing funding at below market
rates - to banks (and building societies) to expand
lending to PNFCs (and households) by reducing
their funding costs which, ultimately, should
translate to lower effective rates of lending and
increased availability of credit. As at Q3 2013,
36
The government intends that the Bank will not
directly lend or invest in businesses; rather, it
(60) See Bank of England (2013d). The changes took effect on
1 January 2014.
(61) Department for Business Innovation and Skills (2013) The
capital will be used to: invest in late stage venture capital
funds which in turn invest in high growth potential SMEs,
launch a scheme to support the provision of lease and asset
finance, and provide wholesale guarantees for loans to
SMEs.
3. Imbalances and Risks
will work in conjunction with the private sector
providers to support and increase the capacity of
existing channels of finance. Such providers may
include challenger banks (see above).
The establishment of the Business Bank is a
positive first step forward. Conceptually and
practically, it enables SMEs to obtain funds that
they may not be able to do so via bank credit.
However, design and implementation will need to
proceed carefully given the complexities of the
issue so that the Bank gains the confidence of
SMEs and potential niche providers of funds to
SMEs. It remains to be seen, however, how
quickly the Bank can provide finance to SMEs on
a scale that helps to meet the gap caused by the
lack of other funding sources and that the leverage
provided by the private sector will materialise to
the extent envisaged. Moreover, it is important that
the Bank operates alongside the market, and
provides funds in a way that is not currently
provided by the market, rather than replace the
market (62).
Competition in the banking sector
PNFCs' access to finance may be affected by the
degree of competition in the banking sector. The
banking sector is characterised by a small number
of large national banks and relatively few regional
banks or regional building societies with a
presence limited to a narrow geographical area.
Moreover, the degree of concentration has
increased since the international economic crisis –
between 2007 and 2013, for the six largest banks:
the share of total assets among all monetary
financial institutions increased from 46% to 55%,
for loans to PNFCs it increased from 64% to 70%
(63).
SMEs are heavily dependent on their own bank
to raise funds. For example, over half of SMEs
that sought finance first approached their main
bank. Moreover, 71% of SMEs contacted only one
provider in seeking finance (64). Anecdotal
evidence suggests that some businesses,
particularly SMEs, are deterred from expansion
and investment if an application is rejected by their
(62) The activities of the Business Bank will need to be
compliant with the EU's State Aid Regime.
(63) Bank of England, unpublished data.
(64) See Breedon Report (2012).
existing bank as they are unable or unwilling to
seek additional sources of finance, including from
other banks.
The dominance of the banking sector, and the
behaviour of SMEs in relation to it, may reflect
information issues in the market. Incumbent
banks have an advantage in relation to retaining
SME business particularly if SMEs have been a
customer of the bank for a long period of time –
allowing the bank to make a full assessment of risk
and hence the collateral and pricing terms of any
loan. More generally, incumbent banks have an
advantage through their provision of current
account facilities which provide them with details
on individual borrowers.
An increase in the number of banks would
provide alternative options for SMEs to seek
finance in the event that an initial application for
finance was rejected by their existing main bank
and wider benefits could be expected to flow from
the increase in competition that such banks could
provide.
A number of small and new so-called
'challenger banks' have commenced operation
in the UK in recent years (65). It is unclear
whether challenger banks will be able to gain
significant market share and, where relevant,
expand activities to the SME sector (66). There is
potential for challenger banks to work with the
Business Bank, once it is established, to provide
access to finance for SMEs. More broadly, the
government has recognised the issue and is
(65) Year established as a stand-alone bank in the UK in
parentheses: Metro Bank (2010), Aldermore (2009),
Handelsbanken (2012) and Virgin Money (2012) although
Metro Bank and Virgin Money have, to date, offered
predominantly retail banking services. Virgin Money is not
technically a new entrant to the market as it has increased
market share by taking responsibility for much of Northern
Rock's previous business.
(66) As argued by the UK Independent Commission on Banking
(2011), for a new bank to inject competitive pressure into
the market, it should have sufficient scale and financial
backbone to act as a challenger bank. In the past, only
banks with a sufficiently high share have been able to grow
and act as challengers to the incumbents. The Commision
on Banking also recommended the creation of a new
challenger bank through the divestiture of assets belonging
to Lloyds Bank. The creation of an independent new bank,
TSB, is underway.
37
3. Imbalances and Risks
considering action to improve competition in the
banking sector (67).
3.3.
THE HOUSING SECTOR AND HOUSEHOLD
MORTGAGE INDEBTEDNESS
3.2.8. Conclusion
Private sector indebtedness remains high;
however, the challenge posed by high private
sector (excluding household secured lending)
indebtedness is less marked than at the time of
the 2013 IDR. In particular, PNFCs remain net
lenders with strong balance sheets that should
provide a cushion against vulnerabilities.
However, credit supply remains muted despite
recent signs from surveys that demand for, and
supply of, credit may rise.
The main challenge is constrained access to
funds, impeding PNFCs' ability to expand and
invest. Excessive reliance on the banking sector for
funds could constrain access to finance. A further
risk relates to distributional issues, especially
remaining high indebtedness in the property and
property-related sectors.
The government's policy response is welcome:
the Business Bank should, once operational, help
SMEs obtain alternative sources of funds and the
recent refocussing of the FLS towards PNFCs only
is appropriate.
There are particular risks and challenges
associated with high household mortgage
indebtedness - flowing from risks and challenges
associated with the housing market - given the
high proportion of outstanding mortgage debt in
total household debt. This issue is considered in
Section 3.3.
(67) For example, the government is consulting on proposals to
require banks to share information on their SME customers
with other lenders through credit reference agencies. The
Office for Fair Trading is collecting evidence on the anticompetitive practice of banks potentially requiring SMEs
to open or maintain a business current account in order to
qualify for a loan.
3.3.1. Introduction
The 2013 IDR concluded that high levels of
household debt and developments in the
housing sector posed a challenge to the economy
noting that 'the macroeconomic imbalances that
the UK is experiencing pose a more immediate
threat to growth than to stability but, if not
addressed, they could store up future risks to
macroeconomic stability and to the financial
sector'.
The housing sector is unusually important in
the UK economy. Households' residential building
assets account for some 400% of households'
disposable income – a marked increase from the
230% of post-tax income in 1997 (the previous
trough) and approximately equal to the share of
financial assets in disposable income. Household
debt has also increased over the medium term,
from 90% in 1997 to 140% of disposable income
in 2011.
Although residential investment accounts for
only around 3% of total output, the housing
sector potentially impacts on economic growth
and stability in a way that is disproportionate to
its share in output. Residential investment
decreased by around 40% from its peak in 2007 to
its trough in 2009 – greater than the fall in total
output of around 6% from its peak in 2007 to its
trough in 2009.
House price movements can outstrip those in
retail prices. For example, house prices increased
by around 150% between January 2000 and their
peak in late 2007 compared to an increase of 15%
in the Consumer Prices Index (CPI) over the same
period. Since their trough in early 2009, house
prices have risen by around 20% while the CPI has
risen by around 16%.
The rate of homeownership is above that of
other large EU Member States – such as France
and Germany – but below that of others – such as
Spain and Italy (Graph 3.33).
38
3. Imbalances and Risks
Graph 3.33: Homeownership rate
100
Graph 3.35: Number of loans approval for house
purchase and for remortgaging, seasonally
adjusted
90
100
(% of total population)
80
90
80
Thousands
70
60
50
70
60
50
40
30
20
40
10
0
30
DE
DK
NL
AT
FR
FI
SE
UK
PL
LU
CY
PT
CZ
BE
MT
EL
IE
IT
SI
ES
SK
BG
LV
EE
LT
HU
RO
00 01 02 03 04 05 06 07 08 09 10 11 12 13
Approvals for house purchase
Approvals for remortgaging
Source: Eurosystem Household Finance and Consumption Survey
Source: British Bankers' Association
Activity
Over the past year, activity in the housing
sector has increased further but remains below
the peaks of 2007 and early 2008. Property
transactions have increased steadily throughout
2012 and 2013 to reach 300,000 in Q3 2013 –
more than double the trough in early 2009 (Graph
3.34).
Moreover, short-term forward indicators of
near-term activity, such as the high sales-stock
ratio and the net balance of new buyer enquiries
and newly agreed sales, suggest that rising levels
of activity will continue (68) (Graph 3.36). The
positive near-term outlook is supported by
indicators for demand for credit for house
purchases.
Graph 3.36: Measures of near-term demand
80
40.0
60
35.0
40
30.0
20
25.0
0
20.0
-20
15.0
300
-40
10.0
250
-60
5.0
200
-80
Graph 3.34: Property transactions
Net Balance
500
450
400
Thousands
350
0.0
08
150
100
%
3.3.2. Trends and Developments
09
10
11
New Buyer Enquiries (lhs)
12
13
Agreed Sales (lhs)
50
Sales to stock ratio (rhs)
0
05
06
07
08
09
10
11
12
13
Source: HM Revenues and Customs
The number of mortgage approvals has also
picked up and continues to increase at a steady
pace and is at its highest level since late 2009.
Mortgage approvals for house purchase and remortgaging have both picked up although the
increase in activity is greater for mortgages for
house purchase (Graph 3.35).
Source: RICS Housing Market Survey Data
Rising levels of activity reflect rising demand
for housing. A number of factors may have
contributed to buoyant demand.
First, quoted interest rates on fixed and floating
rate mortgages have continued to fall
throughout 2012 and 2013 across a range of
mortgage products (Graph 3.37). Broadly, the fall
in quoted mortgage rates may reflect a fall in
(68) Royal Institute of Chartered Surveyors (RICS) Residential
Market Survey December 2013.
39
3. Imbalances and Risks
banks' funding costs over this period, for example,
the two year swap rate has also fallen (Graph
3.38).
50
40
Graph 3.39: Net balance of consumers that believe
that now is a good time in which to make a major
purchase
-15
20
Graph 3.37: Quoted mortgage rates
-20
10
10
-5
-10
30
12
0
-25
0
-30
8
-10
-35
6
-20
-40
4
-30
05Q1 06Q1 07Q1 08Q1 09Q1 10Q1 11Q1 12Q1 13Q1
-45
2
Major purchases over next 12 months (lhs)
Major purchases at present (rhs)
0
03
04
05
06
07
08
09
10
11
12
Source: GfK and Commission Services
13
Personal loan
Bank Rate
Bank Rate tracker mortgage
Two-year fixed-rate mortgage (75% LTV)
Two-year fixed-rate mortgage (90% LTV)
Five-year fixed-rate mortgage (75% LTV)
Source: Bank of England and Bloomberg
Graph 3.38: 2-Year fixed mortgage Rate and 2Year Swap Rates
2.0
4.0
1.5
3.0
1.0
2.0
0.5
1.0
%
5.0
%
2.5
0.0
0.0
09
10
11
12
13
2-year swap rate (lhs)
75% LTV 2-year fixed rate (rhs)
Source: Capital Economics
Moreover, the impact of the Bank of England's
statements regarding the future impact of
monetary policy, may have boosted households'
confidence to purchase houses in the expectation
that interest rates may remain low for an extended
period of time.
Second,
households'
confidence
and
expectations of future income may have risen
throughout 2013 in part reflecting the increase
in growth in this period. Survey measures of
households' expectations in relation to their
personal financial position, unemployment and
general economic situation all improved in 2013.
In addition, there has been a steady increase in
consumers' confidence that now is a good time in
which to make a major purchase (Graph 3.39).
40
Third, credit conditions facing households
continue to ease as improved conditions in the
banking sector mean that households are
subject to weaker credit constraints than in the
immediate past. The availability of, and spreads
on, secured loans to households have improved
since their troughs in early 2012, indicating
loosening credit conditions. Since June 2012,
mortgage lending rates have fallen by 0.6-1 pps.
depending on the type of mortgage. Credit
availability is expected to improve further in Q1
2014 (69). In addition, the number and range of
mortgage products available has increased and the
proportion of loans at a loan-to-value ratio of over
95% is rising. Furthermore, the proportion of new
mortgage advances with high income multiples of
all new mortgage advances is increasing and
stands at 42% compared with 38% a year ago and,
for first-time buyers, the median mortgage as a
multiple of income has steadily risen from a trough
in February 2009 (of 3) to stand at 3.4 in
December 2013 (70). However, easing in credit
conditions is likely to be reflected in the stock of
credit outstanding to households secured on
dwellings with a lag. Credit outstanding grew at a
3-month annualised rate of 1.3% in the year to
December 2013, a little more than double that at
December 2012 and similar to the previous peak of
March 2012.
Fourth, Government policy is also likely to have
increased demand for housing, namely, through
the impact of the Funding for Lending Scheme
(69) See Bank of England (2014).
(70) A high income multiple is defined as 4 or higher on a
single income or 3 or higher on a joint income. Source:
Bank of England (2013b), Capital Economics (2014a and
b)
3. Imbalances and Risks
(FLS) (71) and Help to Buy policy. The second
stage of the scheme, Help to Buy 2 (loan
guarantee), which came into effect in October
2013, enables households to purchase a property of
up to GBP 600,000 in value with a 5% deposit and
with the government guaranteeing 5-15% of the
loan. The objective is to support households to
obtain a loan that they may not otherwise be able
to do. Although recently withdrawn for lending to
households (see below), the FLS was in force until
the end of 2013 and may have contributed to the
falling in the cost of borrowing noted above.
Fifth, buoyant demand is likely to reflect a
delayed response to high levels of unmet
demand during the economic downturn and
international economic crisis – the result of a
structural imbalance between high demand and
low supply.
Moreover, there has been a marked increase in
indicators of future starts and completions - for
example, planning approvals granted in Q3 2013
were 33% higher than a year earlier (73).
The increase in supply is already placing
pressure on capacity in the construction sector.
For example, there have been reports of shortages
of skilled labour (74) and materials (75) that may
impede builders' ability to respond to the need to
increase supply to meet increasing demand.
Government policy and supply
A number of policies to stimulate supply have
been announced since the 2013 IDR. The most
significant development is a set of measures to
strengthen the National Planning Framework
(NPF) to ensure that economic factors are at the
heart of the planning decisions (76)(77).
Supply
The increase in demand is slowly translating
into increased construction of new property.
UK-wide data show that starts and completions
were broadly unchanged in 2011 and 2012 but
began to pick up in Q2 2013 (Graph 3.40). For
England, more recent data suggests that housing
starts picked up in Q3 2013 - starts averaged a
little over 10,800 per month in that quarter
compared to around 8,300 per month in 2012 (72).
Graph 3.40: Private sector housing starts and
completions
70
Thousands
60
50
40
30
20
00 01 02 03 04 05 06 07 08 09 10 11 12 13
Housing starts
Housing completed
Source: Department for Communities and Local Government
(71) A brief explanation of the FLS can be found in Section
3.2.8.
(72) The data in this sentence is for England only as data for the
UK after Q2 2013 had not been published at the time of
publication of the IDR.
House prices
Despite some increase in supply, the increase in
demand has resulted in increases in house
prices. House prices increased by around 8% in
the year to Q4 2013 and the average pace of
growth has picked up from 2012 (78). House price
levels are close to the level of the previous peak in
2008 (Graph 3.41). Moreover, house prices rises
are occurring from already elevated levels.
A number of indicators indicate that buoyancy
in house prices will continue in the near term.
For example, the selling price achieved as a share
(73) See Home Builders Federation (2013).
(74) See, for example, UK Commission for Employment and
Skills (2014).
(75) See, for example, Construction Products Association
(2013).
(76) See HM Treasury (2013).
(77) In December 2013, the government announced that it
would consult on a proposal for a legal requirement for
local authorities to have a local plan in place. Local plans
need to set out expected demand for housing and the
impact of economic factors such as employment and
growth. Moreover, local authorities would be required by
the NPF to take decisions in accordance with their local
plan. If a local authority did not have a local plan in place
and, therefore, is unable to demonstrate that an application
for development is inconsistent with its objectives, then
that application is treated as approved.
(78) According to the most recent monthly data, in the twelve
months to January 2014, house prices increased by 8.8%
and 7.3% according to the Nationwide and Halifax price
indices respectively.
41
3. Imbalances and Risks
of asking price and surveyors' expectations for
house price rises are projected to rise (Graphs
3.42a and b).
Graph 3.41: House Price Index
110
100
2005=100
90
80
70
Affordability
Despite the rise in house prices housing
affordability remains, broadly, at its level of the
past four years. Although the cost of borrowing
remains low and modest nominal disposable
income growth continues, both factors have been
matched by the rise in house prices leaving
affordability broadly unchanged. The pattern is
confirmed by recent movements in the house
prices to rent ratio which has also remained
broadly unchanged over the past four years.
Nevertheless, both measures of affordability
remain at high levels (Graph 3.43 and 3.44).
60
Graph 3.43: House prices to disposable income
50
120
40
00Q4
02Q4
04Q4
06Q4
08Q4
10Q4
110
12Q4
100
2010=100
Source: Commission services
90
80
Graph 3.42a: Selling price achieved as a share
of the asking price
98
70
60
96
00 01 02 03 04 05 06 07 08 09 10 11 12 13
94
Source: OECD
%
92
90
Graph 3.44: Price to rent
88
120
86
110
84
04
05
06
07
08
09
10
11
12
13
100
2010=100
03
Source: Bank of England
90
Graph 3.42b: House price expectations
12-months ahead
80
80
80
70
60
70
40
60
20
50
60
00 01 02 03 04 05 06 07 08 09 10 11 12 13
Source: OECD
0
40
-20
30
-40
-60
20
09
10
11
12
13
RICS house price expectations (lhs)
Knight Frank future sentiment (rhs)
Source: RICS and Knight Frank
42
Furthermore, a third measure of housing
affordability, mortgage interest payments as a
percentage of income, remains subdued,
reflecting the importance of the continued low cost
of borrowing in maintaining improved levels of
affordability compared to the situation before the
international economic crisis (Graph 3.45).
3. Imbalances and Risks
9
Graph 3.45: Mortgage interest payments as a
percentage of household disposable income
35
8
7
30
x 10000 GBP
6
% of GDI
Graph 3.47: Regional house prices
(change in levels)
5
4
3
25
20
15
2
10
1
0
00
01
02
03
04
05
06
07
08
09
10
11
12
Interest payments / gross disposable income, Households
Interest payments / gross disposable income, Households, EA17
Source: Commission Services
2012
Regional house price movements
Graph 3.48: Housing affordability by region
14
12
10
Ratio
Momentum in house prices varies across the
regions. As can be seen in Graph 3.46, house price
rises have been steepest in London since 2012,
followed by the south east. House price rises
outside London and the south east of England have
been considerably more modest.
2013
Source: Nationwide Building Society
8
6
4
2
0
97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13
North West
South West
London
Wales
South East
Scotland
Source: Nationwide Building Society, Halifax and Office for
National Statistics
% yoy
10
8
6
4
2
0
-2
-4
-6
-8
-10
Graph 3.46: Regional house price
developments
2012
2013
Source: Nationwide Building Society
Moreover, the steep house price rises in London
have occurred from a higher base; the average
house price in London is now considerably
higher than that in any other region (Graph
3.47). The high level of house prices in London
has contributed to a reduction in affordability in
London relative to other regions of the UK (Graph
3.48).
The difference in house price rises may reflect
the different and prospective economic
performance of the regions in the UK. It may
also reflect factors specific to London, for
example, the influence of foreign investors which
make cash payments for property and who are
attracted by the 'safe haven' status of the property
market although the evidence to support this view
is largely anecdotal. Moreover, the relative
strength of London is unlikely to be a short-term
phenomenon; there is a medium-term trend for
large cities to outperform the rest of the economy
(79). The study found that in some 'superstar' cities,
house prices continually rise above the national
average over a period of around 50 years.
Given the importance of London in the UK
economy, it is unsurprising, that house price
growth in London has outstripped that in the
rest of the UK. Over the medium term, it is
(79) As argued by Gyoruko, Mayer and Sinai (2006).
43
3. Imbalances and Risks
reasonable to expect the trend to continue. If it
does, the high and rising house rises in London
pose challenges to the authorities in terms of the
affordability of houses in London, particularly for
lower income groups, and labour mobility between
regions of high and low house prices.
The risks associated with rising house prices are
likely to translate into increasing risks relating
to household debt. Rising house prices can be
expected to result in a rise in household
indebtedness over the short and medium term as
cumulative rises in new mortgage debt outstrip
repayments of mortgage debt (Graph 3.50).
3.3.3. Risks
Graph 3.50: House prices and mortgage debt
300
250
200
1999=100
Four risks are discussed below: 'excessive' rises
in activity, house prices and mortgage
indebtedness, an unexpected rise in the cost of
borrowing, a negative income shock, an excessive
relaxation of credit standards and an inadequate
response of supply.
150
100
Excessively rapid increases in the level of
activity, mortgage debt and house prices
50
0
Most quantity-based measures of housing sector
activity are rising. However, activity is increasing
from a low base and remains well below previous
peaks. For example, the number of transactions,
completions and building approvals remain below
their peaks of 2008 as noted above.
Nevertheless, even at modest levels of activity,
house prices are rising (Graph 3.49). As
discussed above, near-term indicators point to such
rises continuing and, possibly, intensifying. Past
experience suggests that present house price rises
can be followed by further increases in house
prices and be followed by self-fulfilling
expectations of future price rises. Such rises may
induce further increases in supply and, of
themselves, deter demand.
145
30
25
20
15
10
5
0
-5
-10
-15
-20
125
000s
105
85
65
45
25
98
00 02 04 06 08 10 12
Mortgage approvals for house purchases (lhs)
Nationwide house prices (rhs)
%y/y
Graph 3.49: Mortgage approvals and house
price growth
99 00 01 02 03 04 05 06 07 08 09 10 11 12 13
Nominal house price index
Loans for house purchasing
Source: Nationwide
Although the stock of outstanding mortgage
debt has increased modestly, it is, nevertheless,
rising from high levels. Given the extent of house
price rises, it could be expected to rise further ( 80).
Rising mortgage debt may leave households
vulnerable to: a rise in the cost of borrowing, an
unexpected shock to household disposable income
and excessive relaxation of credit standards (in
which households acquire excessive debt). These
risks are discussed below.
However, house prices are rising rapidly only in
London (and, to a lesser extent, the south east of
England). Outside these regions, there has been
modest evidence of house price growth and no
evidence of excessive house price growth. Indeed,
the affordability of housing has yet to deteriorate
significantly outside London and has remained
broadly unchanged for four years.
Therefore, until rapidly rising house prices
spread beyond London and the south east of
England, the risks associated with house price
rises are assessed as moderate in the short term.
However, should, in the medium term, rapid house
Source: Bank of England, Nationwide Building Society
(80) Rises in household indebtedness are projected by the
Office for Budget Responsibility (2013).
44
3. Imbalances and Risks
price rises spread more widely across the UK then
the medium-term risks become pronounced.
Rises in the cost of borrowing
The main risk associated with high and rising
household debt is the sensitivity of such debt to
rises in interest rates. As noted above, quoted
mortgage rates have been low and stable for the
past four years. This reflects low yields in the
money markets. However, as assessed by market
expectations of future rises in the bank rate,
forward market rates are projected to rise in the
next 18-24 months (Graph 3.51). Moreover, as
2013 and 2014 have progressed, the date at which
money market rates are projected to rise has
become closer(81); it is reasonable to expect that a
rise in money market rates translates into a rise in
mortgage rates.
Graph 3.51: Market expectations of future
yields
2.5
2
1.5
1
0.5
0
09
10
11
12
Bank Rate
August 2013 Report
13
14
15
16
November 2013 Report
May 2013 Report
Source: Bank of England and Bloomberg
The extent of the rise in rates faced by
increasingly indebted households depends on
whether rates on their mortgages are fixed or
variable. Typically, the majority of loans taken
out are variable rate mortgages. In Q3 2013 around
two-thirds of new mortgage loans were variable
rate mortgages (82) – a proportion in line with that
of the last five years. As a result, the increase in
mortgage rates following a rise in market rates
could be swift. Moreover, households may not
have fully taken into account such a rise in their
calculations on their ability to service mortgage
debt in terms of either magnitude or timing (81) Dates are indicated according to the date of various
Inflation Reports published by the Bank of England.
(82) Bank of England (2013e).
unexpected rises in credit costs can be an example
of 'dangerous near-sightedness' (83) which can
result in a sharp correction in house prices and
activity with macroeconomic consequences.
Crucially, as noted above, mortgage interest
payments as a percentage of income are at
relatively low levels reflecting a cost of
borrowing that is historically low. In addition,
household gearing ratios (i.e. interest and mortgage
repayments as a percentage of disposable income
also remain at historic low levels). There would
seem to be at least some scope for households, in
aggregate, and in the short term, to absorb a
modest rise in mortgage interest rates should the
risk eventuate.
However, in the medium term, the risk is more
pronounced. A sequence of rises in the cost of
borrowing following a rapid rise in house prices
and mortgage indebtedness could leave households
vulnerable in the face of higher levels of mortgage
indebtedness. The Governor of the Bank of
England (2013) (84) has warned households of the
risks posed by possible future increases in the costs
of borrowing.
Furthermore, the aggregate position masks
vulnerabilities across household type. High
levels of debt have amplified the impact of shocks
on income but the degree of amplification is
greater for highly indebted households ( 85). An
unexpected rise in the cost of borrowing is,
therefore, likely to have a disproportionate impact
on highly indebted households.
Overall, although households are increasingly
vulnerable to rises in the cost of borrowing, the
impact of such a risk on the economy is assessed
as moderate in the short term.
A negative shock to household disposable
income
A further risk is an unexpected decline in
household disposable income growth (or future
expected income growth). Should the risk
eventuate, the ability of households to service the
mortgage stock may be reduced.
(83) Glaeser et al (2008).
(84) Governor of the Bank of England (2013).
(85) Bank of England (2013c).
45
3. Imbalances and Risks
However, this risk needs to be set against a
positive, and improving, economic outlook.
Economic growth has surprised on the upside and
is expected to continue at a strong rate in 2014 and
2015 (86). Continued growth in nominal disposable
incomes is consistent with nominal economic
growth. Moreover, such growth supports
households' ability to service increased mortgages.
Even if growth in nominal household disposable
income remains below that of house prices, and
mortgage indebtedness, there may be scope for
households to run down savings further to service
such debt as the household saving ratio remains
well above its trough of 2008. Over the longer
term, rates of arrears and repossessions have
remained low, even during the crisis and
subsequent recession, suggesting that households
remain resilient to shocks (Graph 3.52).
4.0
Graph 3.52: Mortgage arrears and
repossession rates
Graph 3.53: Proportion of mortgage
applications approved (% balance)
0.9
40
3.0
0.7
20
0.6
0
0.5
2.0
0.4
1.5
%
0.8
%
3.5
2.5
%
The signs of the risk materialising are mixed.
On the one hand, some indicators suggest a
relaxation of standards that rivals or exceeds that
of the previous sharp and prolonged rise in house
prices. For example, the share of new mortgages
for house purchase with a loan to income ratio
greater than 4.5 has increased steadily since the
trough in 2009 and, for properties of a value of
GBP 300,000 or more, and for all properties in
London, is well above previous peaks of 2007.
Furthermore, more than half of first home buyers
have taken out mortgages with a repayment period
exceeding the typical 25 years. On the other hand,
however, the proportion of lenders expecting to
increase mortgage applications is not expected to
continue (Graph 3.53). Also, on other measures,
there are signs that standards remain conservative.
-20
0.3
-40
1.0
0.2
-60
0.5
0.1
-80
0.0
0
expected
09
10
11
12
13
14
90 92 94 96 98 00 02 04 06 08 10 12
Availability of High LTV mortgage
Mortgage arrears (lhs)
Proportion of loans approved
Properties taken into possession (rhs)
Source: Bank of England
Source: Department for Communities and Local Government
Therefore, the likelihood of the risk occurring
in the short-term, and its impact, is assessed to
be modest. However, rising levels of house prices
and mortgage indebtedness leave households
exposed to the risk of a negative income shock in
the medium term.
Excessive relaxation
increases in availability
of
standards
and
There is a risk that the relaxation of credit
standards and conditions could intensify and
excessive credit made available to households.
Further relaxation of credit standards could be
excessive particularly if it further boosts house
prices or vulnerable households acquire excessive
debt and may be unable to service such debt.
(86) As set out by European Commission (2014).
46
In any case, the authorities have responded to
the risk - primarily by way of the Financial
Conduct Authority's Mortgage Market Review
(MMR) (87). The MMR is due to come into force
in 2014. Banks will be required to verify fully
borrowers' incomes and assess that a mortgage is
affordable given net income and essential
expenditure, taking into account market
expectations of future interest rate rises. For
interest-only mortgages, lenders will be required to
assess affordability on a capital and interest basis.
(87) In addition, other actions taken by the authorities mitigate
the risk: the FLS can no longer be used to provide credit
for housing (see section 3.3.4), the Prudential Regulation
Authority (PRA) has ended its temporary capital relief on
new household lending qualifying for the FLS and the
Financial Conduct Authority requires mortgage lenders to
have regard to any future FPC recommendations on
appropriate interest rates stress tests to use in the
assessment of loan affordability.
3. Imbalances and Risks
Given the ameliorative measures in place, the
risk of excessively low credit standards is
assessed as modest. The measures underway
should limit the risks associated with excessive
mortgage lending to households and hence their
vulnerability to unexpected rises in the future cost
of borrowing or unexpected falls in future income.
Prudent balance sheets
There is little risk to balance sheets stemming
from increased activity in the housing market.
Households' real assets accounts for about half of
households' total wealth. Households' mortgage
debt accounts for about 10% of households'
balance sheets. Therefore, households' hold
considerable net wealth so their balance sheets are
relatively strong despite high gross household debt
levels (88). The structure of households' balance
sheets increases resilience to shocks discussed
above although this is an aggregate position and
masks differences between households.
shock, the price response is higher in countries
with constrained supply.
The supply responsiveness - which has been
estimated at 0.4 (91) - is likely to be lower than
that for demand and is reasonably inelastic. The
typical experience of UK housing cycles is that
house price rises, and the rise in the number of
transactions, rapidly outstrip increases in
residential construction as discussed above.
The size of the supply response depends upon
the responsiveness of the factors determining
the availability of land that can be developed.
Such factors include: fundamental geographic and
demographic constraints, the planning system,
insufficient incentives to for developers to develop
land and/or constraints in obtaining finance.
Evidence suggests that the elasticity of supply is
associated with restrictions surrounding land use
(92) and, moreover, that the elasticity of supply in
the UK is around the average of EU comparative
countries for which data is available (Table 3.1).
Inadequate response of supply
There is a risk that the supply of new houses
does not respond to the signals sent by rising
house prices. As noted above, supply has been
slow to respond to recent increases in demand and,
as a result, house prices are rising from an already
elevated base. The extent to which increases in
demand translate into higher prices or increased
supply depends upon the price elasticity of the
demand curve – the more price-inelastic the supply
curve, the higher the prices that will result for a
given increase in demand.
(91) OECD ibid.
(92) See OECD ibid.
The sluggish response of supply to price signals
is a typical feature of housing markets
internationally (89) but nevertheless, a divergent
response in supply could explain house price
dispersion across countries. For example, one
study (90) found that, following a house price
(88) However, although the aggregate solvency risk seems
small, there is liquidity risk, for example, a proportion of
households' financial assets are likely to be held as
insurance reserves which are less liquid than other forms of
financial assets.
(89) see e.g. OECD (2008).
(90) Gattini and Ganoulis (2012).
47
3. Imbalances and Risks
government's stated policy of increasing the supply
of houses are given appropriate weight.
Table 3.1:
Elasticity of supply
Country
Regulation
restriction
BE
0.32
DK
1.21
DE
0.43
IE
0.63
ES
0.45
FR
0.36
IT
0.26
NL
0.19
AT
0.23
PL
0.44
FI
0.99
SE
1.38
UK
0.40
Source: OECD
Planning system
The role of the planning system in impeding
supply has come under particular focus. It has
been argued that the planning system is
excessively bureaucratic and unresponsive to
changes in demand (93). As a result, the supply of
land is restricted and the costs of developing it are
unnecessarily high. The constraints may be
particularly tight around large cities in which land
designated as 'green belt' is protected from
development.
Decisions relating to the supply of land
available for housing development are typically
taken by local authorities in the first instance
although such decisions are subject to appeal
which is assessed as part of an independent
process. As part of these processes, the planning
system attempts to balance legitimate competing
interests on the use of land. Achieving such a
balance is not straightforward in practice.
However, in balancing competing interests it is
crucial that the role of economic factors and the
(93) UK Government (2012).
48
It is unlikely that supply will increase
sufficiently rapidly to meet increases in demand
in the short term - although the government has
announced, and is implementing, a number of
policies to boost supply, given the constraints and
time likely to elapse before such policies take full
effect, constraints on supply are likely to continue.
A further risk is that developers obtain
planning permission to develop land but do not
proceed with the development. Reasons for such
action include: an inability to obtain development
finance, an unexpected shortage of materials or
skilled labour or speculation about future capital
gains. Should such action be significant, the supply
of land for development is restricted. It is difficult
to assess the extent of this risk in practice. It is also
important to note that at least some land banks are
inevitable as developers seek to manage an
appropriate continual supply of land of
development in the pipeline. However, it is
noteworthy that planning permission expires if
land is not developed within a particular
timeframe.
Capacity constraints
As noted above, there is evidence that the
construction sector may be experiencing
capacity constraints. Firms typically report that
they are at or near capacity; should capacity
constraints continue, the risk that supply is unable
to increase to meet growing demand is intensified.
Medium-term
demand
gap
between
supply
and
More broadly, a shortage of supply is unlikely
to be a short-term phenomenon and could
extend to the medium term. Medium-term
demand for new houses is likely to be determined
by the rate of new household formation. It is
currently projected that, in England, an average of
around 220,000 households will be formed each
year between 2012 and 2021 (94). However, new
(94) Department of Communities and Local Government
(2013d).
3. Imbalances and Risks
supply is currently around 110,000 per year (95) –
well below the rate of new household formation.
The imbalance between supply and demand is
likely to underpin currently high house price levels
and spur further rises in house prices over the
medium term as demand outstrips supply.
Risks - conclusion
In conclusion, levels of activity remain below
previous peaks. Nevertheless, house prices are
rising and the increase in prices and level of
activity is likely to be reflected in rising levels of
mortgage debt (and that rise is occurring from an
already elevated base). The main risk on the
demand side is households' vulnerability to a rise
in the cost of borrowing while the response of the
authorities has mitigated risks associated with an
excessive lowering of credit standards. The main
risk on the supply side is that reforms to the
planning system and other initiatives to increase
supply do not deliver increases in new housing of
the amount required, or do so sufficiently quickly,
to forestall further rises in house prices and
mortgage indebtedness.
Overall, the short-term risks are rising but
remain modest. The rise in activity is based on
stronger fundamentals in the housing market –
improved confidence, a low cost of borrowing and
some, and not wholly on an excessive relaxation in
credit availability and standards.
However, in the medium term, as house prices
and household mortgage indebtedness become
increasingly elevated, the risks are more
marked, as households are more exposed should
the cost of borrowing rise rapidly and/or a negative
income shock eventuates. There is, therefore, a
case for a policy response to mitigate the impact of
potential medium-term risks
(95) Department of Communities and Local Government
(2013c).
3.3.4. Government policy - responses and
challenges
Demand
Help to Buy 2
As noted above, under Help to Buy 2, the
provision of guarantees by the government
improves households' ability to obtain high
value loans with a relatively small deposit. Help
to Buy 2 compliments the earlier Help to Buy 1
(96) but there are significant differences on the
impact on relative demand and supply. Under Help
to Buy 1, there is an increase in the supply of new
property to match each new equity loan whereas
the guarantee under Help to Buy 2 extends to preexisting property and is unlikely to generate a
similar simultaneous increase in new supply (97).
The impact of Help to Buy 2 on housing activity
and prices depends partly upon its size. The
policy, which is in place for three years, is capped
at a total exposure to the Government of GBP 12
billion, and could be expected to lead to a
maximum increase in loans available of around
GBP 100 billion. Even assuming a mid-point
estimate of a contingent liability of GBP 6 billion,
the increase in mortgage lending of around GBP
50 billion over three years is significant although it
is difficult to assess the 'additionality' afforded by
Help to Buy 2 – that is, the number of loans that
would have been provided to the same households
in the absence of the policy. However, and as is
also the case for Help to Buy 1, Help to Buy 2 is
likely to have boosted general confidence in the
housing market and exerted an impact more widely
on prices and activity.
In the absence of a strong supply response, the
predominant impact of Help to Buy 2 is likely to
increase house prices; indeed, supply is likely to
respond only indirectly and slowly given its
(96) Under the Help to Buy 1 (equity loan) scheme that came
into effect in April 2013 the UK Government provides an
equity loan of between 5 and 20 per cent for households
seeking a loan for the purchase of a new property of up to
GBP 600,000 in value with a minimum deposit of 5%. The
aim of the policy is to enable households to purchase new
build property but would otherwise lack the funds
sufficient to obtain a deposit to do so.
(97) As at December 2013, around 13,000 equity loans had been
completed under Help to Buy 1 of which a little under 1000
were in London boroughs. See Department of
Communities and Local Government (2013a)
49
3. Imbalances and Risks
historically lagged and muted response to price.
House prices are likely to rise further at a time in
which house prices are already rising although the
extent of any increase depends on the regions in
which guarantee loans are provided for purchase
(98). The policy is also likely to increase household
indebtedness – although part of that increase in
debt is guaranteed by the government.
At a time in which credit constraints are easing
in the mortgage market, the need for the policy
may diminish. While some constraints remain –
for example, as noted above, the median deposit
required for a first home buyer is currently double
that of 2008 while that for all home buyers has
been volatile but broadly unchanged – the policy is
not explicitly targeted to such segments of the
market (99).
Close monitoring of credit availability and
associated macroeconomic developments is
required (100) given the risks associated with
Help to Buy 2 and the policy could be scaled back
– and/or more closely targeted – should credit
supply growth rise further and credit constraints
continue to ease.
The Funding for Lending Scheme
In November 2012 it was announced that the
FLS would be withdrawn for lending to
households – effective from January 2014. Other
factors held constant, the FLS could be expected to
affect the cost of borrowing and/or the quantity of
finance available to households and, as such, could
have boosted housing sector activity in 2013.
The withdrawal of the FLS for lending to
households is appropriate. The need for the
(98) Under Help to Buy 1, as set out in footnote 79, the majority
of equity loans were provided for purchase outside London.
Should a similar pattern of guarantee loans be provided
under Help to Buy 2, then the impact on house prices is
likely to be less than if most loans were provided for
purchase in London.
(99) Although it is worth noting that, as at September 2013,
92% of loans advanced under Help to Buy 1 were to first
home buyers. See DCLG (2013b). Data is not yet available
for guarantee loans under Help to Buy 2 although, under
both arms of the policy, loans are available at only high
loan-to-value ratios, suggesting that first home buyers are
likely to benefit disproportionately.
(100) The Financial Policy Committee of the Bank of England is
required to report to the Government if it believes that the
policy poses risks to financial stability.
50
policy to continue is unclear given buoyant activity
in the housing market and easing access to credit
for households. Continuation of the policy risked
further boosting demand and house prices.
Role of macro-prudential regulation
There may be scope for a regulatory response
by the Financial Policy Committee of the Bank
of England (FPC). Consistent with its
responsibilities for protecting and enhancing the
resilience of the UK financial system, in the event
that it felt that excessive credit was flowing to the
household sector, and that flow posed risks to
financial stability, the FPC could take action to
affect banks' provision of mortgages. Such actions
could include (101):
 decisions on the countercyclical buffer – that
is, to require banks to directly increase lossabsorbing capital against the impact (on banks)
of an economic downturn;
 make recommendations on maximum loan-tovalue ratios, loan-to-income ratios, debt to
income ratios or mortgage terms – to restrict
mortgages of a particular type;
 make recommendations – or directions – to the
Prudential Regulation Authority (PRA) on
bank capital requirements on residential real
estate lending, that is, to require banks to
directly increase loss-absorbing capital against
the impact (on banks) of an economic
downturn;
 make recommendations to the PRA or
Financial Conduct Authority (FCA) on
underwriting standards; and/or
 make recommendations to the Government
regarding its Help to Buy policy.
The FPC only came into existence relatively
recently – an interim FPC held its first meeting
in June 2011 - so it is relatively untested. Many
of the options available to the FPC have been used
in other countries. The FPC's views on the tradeoffs between the benefits, costs, risks and
(101) As set out by the Bank of England) (2013b). Some of these
actions are implemented by powers to give
recommendations or directions to the PRA and the FCA.
3. Imbalances and Risks
unintended side effects associated with the above
suite of options and their relative efficiency and
effectiveness in addressing policy challenges could
be further publicly developed.
There is a case for a more detailed public
assessment by the FPC of the merits of the
various instruments available to it and the
situations in which they would be deployed.
Such an assessment would increase markets'
understanding of the FPC's reaction function
which would boost not only transparency but also
the effectiveness of the instruments if/when they
are deployed.
Valuation of the cadastre
Broadly, taxation of owner-occupied property is
levied through an annual council tax – which is
collected by local authorities and is based on
property values – and taxes on transfers, viz,
stamp duty and inheritance tax. The property value
roll – the basis for the assessment of council tax has not been updated since 1991. The UK is one of
more than half of Member States that levied
property taxes on outdated cadastral values ( 102).
Use of an outdated property value roll may lead
to distortions: owner-occupied property becomes
under-taxed and there is a bias in the tax system to
over-investment in owner-occupied property, the
degree of regression in the tax system increases, as
property values have not increased uniformly
across, or within, regions there can be inter and
intra-country distortions and the amount of tax
collected moves inversely with value of the object
of the taxation. Moreover, regular revaluation of
the roll would reduce sudden increases in the
annual council tax liabilities. However, other
factors held constant, revaluation may lead to a
large, and possibly sudden, increase in taxation,
particularly for groups that have benefitted from
rises in house prices since 1991.
An updating of the property value roll should
reduce distortions in the taxation system. Any
excessive tax increases falling on certain groups
can be mitigated through adjustments elsewhere in
the taxation system (including property taxation).
Housing supply
Until relatively recently, the planning system
did not place appropriate weight on economic
factors such as supporting economic and
employment growth. Reforms enacted by the
government in 2012 and 2013 as part of the
National Planning Framework (NPF) (103) require
local authorities to place economic factors at the
heart of planning decisions including the demand
for housing. A key component is the need to
prepare a Strategic Housing Market Assessment to
assess their full housing needs taking account of
household and population projections, migration
and demographic change and caters for housing
demand and the scale of housing supply necessary
to meet this demand. In addition, 'local plans' are
required that set include the strategic priorities
need to deliver the required number of homes and
jobs in each area.
In December 2013, the government announced
that it would consult on a proposal for a legal
requirement for local authorities to have a local
plan in place. Moreover, local authorities are
required by the NPF to take decisions in
accordance with their local plan. If a local
authority does not have a local plan in place and,
therefore, is unable to demonstrate that an
application for development is inconsistent with its
objectives, then that application is treated as
approved. As at December 2013, 76% of local
authorities had a plan in place.
The reforms to the planning system are
appropriate. Nevertheless, it will take time for
local authorities to fully reflect such criteria when
taking decisions, not least because they will need
to develop the expertise to do so. However, the
increased role played by demand for housing in
determining the supply of developable land for
housing should, in time, stimulate supply and
represents a major change from previous practice.
In addition, it is essential that decisions taken
by local authorities are taken efficiently and
transparently. Delays are minimised so that new
supply can commence as quickly as possible.
(103) Department of Communities and Local Government
(2012).
(102) European Commission (2013i).
51
3. Imbalances and Risks
In order to encourage the release of more land
for development, the government could
consider the appropriate incentive structure for
local authorities to increase and speed up the
release of such land in the context of facilitating
local solutions to the issue. Such local solutions
may also include the taxation of vacant property.
In addition, the government could consider
whether there is a case for a stronger regional
approach to decisions on the supply of land for
development involving clusters of local authorities.
overburden rate' (105) is higher for renters than for
home-owners (Graph 3.54) suggesting that there is
considerable financial pressure on tenants.
80
Share of population (%)
Recent policies announced in 2013 aim to increase
the efficiency of the planning system ( 104).
Graph 3.54: Housing tenure and housing cost
overburden rates
70
60
50
40
30
20
10
0
Tenant
Owner
United Kingdom
In conclusion, the government has undertaken
some reform of the planning sector. Further time
is needed to assess whether they will result in a
timely increase in supply and further analysis is
needed as to whether barriers to supply lie outside
the planning system. However, there is scope to
move further – including the development of
appropriate and targeted incentives for local
authorities to release land with planning
permission attached for development in the context
of local solutions to inadequate supply. Local
solutions may also include the taxation of vacant
property.
Rental sector
In part reflecting a medium-term decline in
housing affordability, the proportion of
households that own a house has decreased in
the UK from 69% in 2001 to 65% in 2013
although the rate of home ownership in the UK is
broadly in line with other EU Member States.
The private rented sector in the UK is relatively
unregulated compared to that in other EU
Member States. The rights of tenants and
responsibilities of landlords are relatively limited.
The rental market may be dominated by a large
number of short-term and relatively insecure
temporary contracts. In addition, the 'household
(104) For example, it has been announced (UK Government
2013a) that the government would: review the Nationally
Significant Infrastructure Planning Regime, consult on
introducing a requirement to have a local plan in place,
address delays associated with the discharge of planning
conditions and reduce the number of applications for which
statutory consultation is required.
52
Housing cost overburden rate
Low inc.
EA17
High inc.
EU27
Owner occupancy rate
Source: Commission Services
Note: Average 2008-2011
There is a case to foster greater stability in the
tenant-landlord relationship in a way that
provides greater security of tenure to tenants.
While some tenants and landlords may prefer
short-term tenancy arrangements others may prefer
greater stability in the form of longer-term
contracts; in particular, some tenants may prefer
long-term tenancy arrangements that landlords are
unwilling to provide (106). Furthermore, uncertainty
regarding tenure in the rental market may
encourage home ownership thus increasing
pressure in the housing market.
3.3.5. Conclusion
Activity in the housing sector can be expected to
increase further. Given the gap between the
formation of new households and supply, demand
is likely to continue to outstrip supply. Relaxation
of credit constraints is also likely to boost demand.
Therefore house price rises are likely to continue
to rise particularly in London. It follows that
household indebtedness is also likely to rise.
(105) The overburden rate is the % of the population living in
households for which the total housing costs (net of
housing allowances) represent more than 40% of
disposable income (net of housing allowances).
(106) For example, according to a recent survey among renters in
London, 66% of respondents wanted reform for 'the option
of a longer-term tenancy so I can settle in my home'. See
Shelter (2013).
3. Imbalances and Risks
The challenge associated with high mortgage
indebtedness is, therefore, likely to persist and
worsen. There are a number of risks associated
with high mortgage indebtedness: excessive rises
in activity and prices, a rise in the cost of
borrowing, a negative shock to household
disposable income, excessive relaxation of credit
standards and an inadequate response of supply.
Although the likelihood of the risks materialising
in the short term is assessed as modest, shocks to
house prices and household balance sheets may
pose more marked medium-term risks.
There is scope for action on the demand and
supply sides of the housing market to reduce
medium-term risks. Given the regional nature of
house prices rises such action may require local
solutions. In the absence of action, the challenge is
likely to worsen further, and persist for longer, and
the risks associated with it are likely to increase.
53
4.
POLICY CHALLENGES
Following from the analysis in Section 3, potential
imbalances relate to both the external and internal
side of the economy, namely, a medium-term
decline in the export share and high private sector
indebtedness, particularly households mortgage
indebtedness.
These challenges were also identified under the
Macroeconomic Imbalance Procedure in the 2012
and 2013 IDRs and relevant policy responses were
reflected and integrated in the country-specific
recommendations (CSR) issued to the UK in July
2012 and 2013 (CSR 1, 2, 3, 5 and 6). The
assessment of progress in the implementation of
the recommendations will take place in the context
of the assessment of the UK National Reform
Programme and the Convergence Programme
under the 2014 European Semester. This section
discusses possible ways to address the challenges
identified in this IDR.
The challenge of export performance
Recent growth is based predominantly on strong
private consumption growth. A shift in the
composition of growth towards exports over the
medium term would be consistent with a reversal
of the trend deterioration in export market share.
To achieve such rebalancing, different policy
approaches could be considered such as:
strengthening the skills base, improving access to
finance, export promotion and increasing
investment in infrastructure.
Closing skill gaps
Correctly accredited vocational training schemes
and concentrating on science, technology,
engineering and mathematics (STEM) in the
education system could help meet the requirements
of employers. Addressing the skills gap would also
address the 2013 Council recommendation on
young people’s skills
Improving access to finance
Alleviating apparent credit constraints could
enhance the ability of exporters to receive the
finance they need to expand into export markets.
Despite measures implemented by the government
to boost credit supply and facilitate access to
alternative sources of finance, credit supply
remains weak, particularly for SMEs.
The government has a number of initiatives in
place to boost access to finance. For instance, the
Funding for Lending Scheme (FLS) was altered in
November 2013 by removing use of the Scheme to
lend to households; the remaining focus on lending
to business enables closer targeting of finance to
business. In addition, the government is
establishing a Business Bank to provide alternative
channels of finance for SMEs beyond bank credit.
The Bank should be operational by the second half
of 2014. SMEs, in particular, rely heavily on bank
finance, thus, improving access to bank finance,
via the FLS, as well as encouraging alternative
sources of finance, via the Business Bank, are
welcome and appropriate initiatives to ensure that
SMEs obtain the finance they need to expand and
export.
To stabilise, and possibly reverse, the decline in
export market share, a key challenge is to ensure
that the labour force has the necessary skills and
aptitudes. A lack of both intermediate and
advanced technical skills can result in capacity
constraints.
Furthermore, continuing to foster greater
competition in the banking sector, e.g. by an
increased presence of challenger banks, may help
SMEs access credit. Initiatives in this area also
respond to the 2013 CSR on improving credit
availability.
In October 2013, the government announced plans
to improve the quality of apprenticeships in
England. Provision of high quality and targeted
apprenticeships can help to boost the availability
of relevant skills. Reviewing the exact nature of
apprenticeships in cooperation with employers
could contribute to meet the needs of the business
and, particularly, the exporting sector.
Broad-based export promotion
There is potential to address information
asymmetries that prevent firms that wish to export
from seizing opportunities to do so. The
government has established a number of initiatives
to provide export credit and other supporting
services; for instance, services provided by UK
Export Finance and UK Trade & Investment.
55
4. Policy Challenges
The effectiveness of these initiatives hinges on
awareness in the business community, as well as
taking appropriate account of regional diversity in
their design. More generally, trade openness relies
on the ability to interact with foreign commercial
partners. Finally, facilitating the recruitment of
foreign experts could improve firms' ability to
engage in international trade.
Investing in infrastructure
A potential bottleneck hindering competitiveness
results from its under-investment in infrastructure.
Improvement in the quality and quantity of
infrastructure could also raise long-term potential
growth by raising productivity. Upgrading and
expanding the transport infrastructure could reduce
bottlenecks in distribution.
The government published an ambitious National
Infrastructure Plan 2013 in December 2013, which
sets out investment plans worth GBP 375 billion to
2020 and beyond. Around two-thirds of the funds
are to be provided by private sources of funds.
Most of the investment is in the energy and
transport sectors and is back-loaded time wise. A
list of ‘Top 40’ projects has been published;
priority projects were chosen based on their
potential contribution to economic growth,
national significance and attractiveness for private
investors. Bringing forward the delivery of these
planned projects where possible and ensuring
effective implementation would boost the impact
of the Plan. Facilitating increased investment in
infrastructure and harnessing private sources of
capital also responds to the 2013 Council
recommendation.
The challenge of private sector indebtedness
Although the pace of deleveraging has slowed, and
corporate indebtedness remains high, PNFCs as a
whole are net savers and hold high levels of
financial assets. However, aggregate PNFCs'
indebtedness masks the divergence between the
construction/property sector and other sectors for
which the size of deleveraging has been greater.
The potential imbalance and risks arising from
private sector indebtedness relate to high
household mortgage debt, which in turn flows
from developments in the housing market.
56
The housing market challenge
Demand for housing continues to increase
particularly in London and the south east of
England. The increase in demand may result in an
increased imbalance in the housing sector in the
short and medium term as the supply of new
houses continues to fall below projected rates of
household formation. House prices are rising
steadily, especially in London and the south east of
England and household mortgage indebtedness is
likely to increase.
Policies to facilitate households' ability to
purchase a house
The purpose of the government's Help to Buy
scheme is to facilitate households' ability to buy a
house. Whilst the first phase of the Help to Buy
scheme ('equity loan' or 'Help to Buy 1') provides
partial loans to facilitate a mortgage for new
houses only, the second phase ('mortgage
guarantee' or 'Help to Buy 2'), applies to all houses
(existing or new). The effect on demand of 'Help
to Buy 2' is likely to be immediate and direct while
that on supply is likely to be indirect and slow
given the historically lagged and muted response
of new supply to demand. Therefore, the policy is
likely to boost house prices further and at a time
when they are already rising. The policy is also
likely to increase household indebtedness,
although part of that increase in debt is directly
guaranteed by the government.
Close monitoring of credit availability and
associated macroeconomic developments is
required given the risks associated with Help to
Buy 2 and the policy could be scaled back – and/or
more closely targeted – should credit supply
growth rise further and credit constraints continue
to ease.
Macro-prudential regulation
Consistent with its responsibilities for protecting
and enhancing the resilience of the financial
system, in the event that the Financial Policy
Committee of the Bank of England (FPC) felt that
excessive credit was flowing to the household
sector, and that flow posed risks to financial
stability, the FPC could take action to affect banks'
provision of mortgages.
4. Policy Challenges
There is a case for a more detailed public
assessment by the FPC of the merits of the various
instruments available to it and the situations in
which they would be deployed. Such an
assessment would increase markets' understanding
of the FPC's reaction function which would boost
not only transparency but also the effectiveness of
the instruments if and when they are deployed.
Reform of property taxation
historically favourable mortgage rates. Given that
much recent new borrowing is at a variable interest
rate, there are potential risks to households' ability
to service mortgages should the cost of borrowing
increase. The reform of the mortgage market in the
Financial Conduct Authority’s Mortgage Market
Review is due to come into force in April 2014 and
is designed to limit particularly high-risk lending
and support the maintenance of high credit
standards and prudent lending.
By EU standards, the share of property taxes in
total government receipts is high in the UK.
However, the efficiency and effectiveness of the
property tax system could be improved. Taxation
of owner-occupied property is levied through an
annual council tax – which is collected by local
authorities and is based on property values – and
taxes on transfers via stamp duty and inheritance
tax. The property value roll – the basis for the
assessment of council tax – has not been updated
since 1991; a revaluation would reduce distortions
in the taxation system in favour of owner-occupied
housing.
Reform of the planning system and supply
Despite improvements in the planning system, a
shortage of supply persists. Better incentives for
local authorities could be considered in order to
increase and speed up the release of land with
planning permission for development in the
context of facilitating local solutions to inadequate
supply. Improvements in this area would also be a
response to the 2013 Council recommendation on
housing.
Promotion of long-term tenancy agreements
The rental market is relatively unregulated by EU
standards. There is scope to foster long-term
tenancy agreements which could benefit both
tenants and landlords. It could also reduce the
tendency towards high home-ownership rates,
which in turn might relieve pressure on rising
house prices, driven by those attempting to get
onto the property ladder.
Curtailing the risk of excessive relaxation of
credit standards
The bank rate is currently at an historic low and
many households are currently able to borrow at
57
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